KT&G Corporation (KRX:033780) Stock's On A Decline: Are Poor Fundamentals The Cause?

It is hard to get excited after looking at KT&G's (KRX:033780) recent performance, when its stock has declined 5.5% over the past three months. Given that stock prices are usually driven by a company’s fundamentals over the long term, which in this case look pretty weak, we decided to study the company's key financial indicators. Specifically, we decided to study KT&G's ROE in this article.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for KT&G

How To 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 KT&G is:

11% = ₩982b ÷ ₩8.8t (Based on the trailing twelve months to September 2020).

The 'return' is the profit over the last twelve months. So, this means that for every ₩1 of its shareholder's investments, the company generates a profit of ₩0.11.

Why Is ROE Important For Earnings Growth?

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

KT&G's Earnings Growth And 11% ROE

On the face of it, KT&G's ROE is not much to talk about. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 16%. Therefore, KT&G's flat earnings over the past five years can possibly be explained by the low ROE amongst other factors.

We then compared KT&G's net income growth with the industry and found that the average industry growth rate was 7.9% in the same period.

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about KT&G's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is KT&G Using Its Retained Earnings Effectively?

KT&G has a high three-year median payout ratio of 52% (or a retention ratio of 48%), meaning that the company is paying most of its profits as dividends to its shareholders. This does go some way in explaining why there's been no growth in its earnings.

In addition, KT&G has been paying dividends over a period of nine years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 61%. As a result, KT&G's ROE is not expected to change by much either, which we inferred from the analyst estimate of 11% for future ROE.

Summary

In total, we would have a hard think before deciding on any investment action concerning KT&G. As a result of its low ROE and lack of mich reinvestment into the business, the company has seen a disappointing earnings growth rate. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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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