Most readers would already know that Cape Industries' (KOSDAQ:064820) stock increased by 6.4% over the past three months. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Specifically, we decided to study Cape Industries' ROE in this article.
Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
How Do You Calculate Return On Equity?
Return on equity can be calculated by using the formula:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Cape Industries is:
5.7% = ₩12b ÷ ₩209b (Based on the trailing twelve months to September 2020).
The 'return' is the amount earned after tax over the last twelve months. That means that for every ₩1 worth of shareholders' equity, the company generated ₩0.06 in profit.
What Has ROE Got To Do With Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.
A Side By Side comparison of Cape Industries' Earnings Growth And 5.7% ROE
On the face of it, Cape Industries' ROE is not much to talk about. However, its ROE is similar to the industry average of 4.9%, so we won't completely dismiss the company. Even so, Cape Industries has shown a fairly decent growth in its net income which grew at a rate of 11%. Taking into consideration that the ROE is not particularly high, we reckon that there could also be other factors at play which could be influencing the company's growth. Such as - high earnings retention or an efficient management in place.
As a next step, we compared Cape Industries' net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 11% in the same period.
Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Cape Industries is trading on a high P/E or a low P/E, relative to its industry.
Is Cape Industries Using Its Retained Earnings Effectively?
Given that Cape Industries doesn't pay any dividend to its shareholders, we infer that the company has been reinvesting all of its profits to grow its business.
Overall, we feel that Cape Industries certainly does have some positive factors to consider. Despite its low rate of return, the fact that the company reinvests a very high portion of its profits into its business, no doubt contributed to its high earnings growth. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. To know the 2 risks we have identified for Cape Industries visit our risks dashboard for free.
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This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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