Korea Electric Terminal Co., Ltd. (KRX:025540) Stock Is Going Strong But Fundamentals Look Uncertain: What Lies Ahead ?

Most readers would already be aware that Korea Electric Terminal's (KRX:025540) stock increased significantly by 45% over the past three months. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. Specifically, we decided to study Korea Electric Terminal's ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for Korea Electric Terminal

How Is ROE Calculated?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Korea Electric Terminal is:

6.6% = ₩49b ÷ ₩743b (Based on the trailing twelve months to September 2020).

The 'return' is the yearly profit. Another way to think of that is that for every ₩1 worth of equity, the company was able to earn ₩0.07 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

Korea Electric Terminal's Earnings Growth And 6.6% ROE

When you first look at it, Korea Electric Terminal's ROE doesn't look that attractive. Yet, a closer study shows that the company's ROE is similar to the industry average of 5.6%. But Korea Electric Terminal saw a five year net income decline of 16% over the past five years. Remember, the company's ROE is a bit low to begin with. Therefore, the decline in earnings could also be the result of this.

However, when we compared Korea Electric Terminal's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 3.6% in the same period. This is quite worrisome.

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). 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 Korea Electric Terminal is trading on a high P/E or a low P/E, relative to its industry.

Is Korea Electric Terminal Using Its Retained Earnings Effectively?

When we piece together Korea Electric Terminal's low three-year median payout ratio of 20% (where it is retaining 80% of its profits), calculated for the last three-year period, we are puzzled by the lack of growth. The low payout should mean that the company is retaining most of its earnings and consequently, should see some growth. So there might be other factors at play here which could potentially be hampering growth. For instance, the business has faced some headwinds.

In addition, Korea Electric Terminal has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth.

Summary

Overall, we have mixed feelings about Korea Electric Terminal. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the earnings growth. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. To know the 2 risks we have identified for Korea Electric Terminal 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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