Is The Market Rewarding Namhwa Industrial Co., Ltd. (KOSDAQ:111710) With A Negative Sentiment As A Result Of Its Mixed Fundamentals?

With its stock down 9.8% over the past three months, it is easy to disregard Namhwa Industrial (KOSDAQ:111710). It seems that the market might have completely ignored the positive aspects of the company's fundamentals and decided to weigh-in more on the negative aspects. Fundamentals usually dictate market outcomes so it makes sense to study the company's financials. In this article, we decided to focus on Namhwa Industrial's ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for Namhwa Industrial

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 Namhwa Industrial is:

2.6% = ₩3.6b ÷ ₩138b (Based on the trailing twelve months to September 2020).

The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every ₩1 worth of equity, the company was able to earn ₩0.03 in profit.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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.

A Side By Side comparison of Namhwa Industrial's Earnings Growth And 2.6% ROE

As you can see, Namhwa Industrial's ROE looks pretty weak. Even compared to the average industry ROE of 4.6%, the company's ROE is quite dismal. For this reason, Namhwa Industrial's five year net income decline of 23% is not surprising given its lower ROE. However, there could also be other factors causing the earnings to decline. For example, the business has allocated capital poorly, or that the company has a very high payout ratio.

However, when we compared Namhwa Industrial's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 27% in the same period. This is quite worrisome.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Namhwa Industrial's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Namhwa Industrial Efficiently Re-investing Its Profits?

Summary

Overall, we have mixed feelings about Namhwa Industrial. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. 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. You can see the 2 risks we have identified for Namhwa Industrial by visiting our risks dashboard for free on our platform here.

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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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