Hankook Furniture Co., Ltd.'s (KOSDAQ:004590) Stock On An Uptrend: Could Fundamentals Be Driving The Momentum?

Most readers would already be aware that Hankook Furniture's (KOSDAQ:004590) stock increased significantly by 38% 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 Hankook Furniture's 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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Hankook Furniture

How Do You Calculate Return On Equity?

The formula for return on equity is:

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

So, based on the above formula, the ROE for Hankook Furniture is:

6.3% = ₩6.7b ÷ ₩107b (Based on the trailing twelve months to September 2020).

The 'return' is the yearly profit. So, this means that for every ₩1 of its shareholder's investments, the company generates a profit of ₩0.06.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

Hankook Furniture's Earnings Growth And 6.3% ROE

On the face of it, Hankook Furniture's ROE is not much to talk about. Yet, a closer study shows that the company's ROE is similar to the industry average of 7.1%. Having said that, Hankook Furniture has shown a meagre net income growth of 4.1% over the past five years. Remember, the company's ROE is not particularly great to begin with. So this could also be one of the reasons behind the company's low growth in earnings.

Given that the industry shrunk its earnings at a rate of 2.1% in the same period, the net income growth of the company is quite impressive.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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 Hankook Furniture is trading on a high P/E or a low P/E, relative to its industry.

Is Hankook Furniture Using Its Retained Earnings Effectively?

A low three-year median payout ratio of 24% (implying that the company retains the remaining 76% of its income) suggests that Hankook Furniture is retaining most of its profits. However, the low earnings growth number doesn't reflect this as high growth usually follows high profit retention. Therefore, there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Additionally, Hankook Furniture has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth.

Conclusion

In total, it does look like Hankook Furniture has some positive aspects to its business. With a high rate of reinvestment, albeit at a low ROE, the company has managed to see a considerable growth in its earnings. 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. Our risks dashboard would have the 3 risks we have identified for Hankook Furniture.

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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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