Weak Financial Prospects Seem To Be Dragging Down KT&G Corporation (KRX:033780) Stock

With its stock down 4.8% over the past month, it is easy to disregard KT&G (KRX:033780). We decided to study the company's financials to determine if the downtrend will continue as the long-term performance of a company usually dictates market outcomes. Specifically, we decided to study KT&G's ROE in this article.

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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for KT&G

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 KT&G is:

10% = ₩930b ÷ ₩9.3t (Based on the trailing twelve months to December 2023).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each ₩1 of shareholders' capital it has, the company made ₩0.10 in profit.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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 10% ROE

At first glance, KT&G's ROE doesn't look very promising. Yet, a closer study shows that the company's ROE is similar to the industry average of 12%. Having said that, KT&G's net income growth over the past five years is more or less flat. Bear in mind, the company's ROE is not very high. Hence, this provides some context to the flat earnings growth seen by the company.

We then compared KT&G's net income growth with the industry and found that the average industry growth rate was 7.3% in the same 5-year 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. This then helps them determine if the stock is placed for a bright or bleak future. Is A033780 fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is KT&G Using Its Retained Earnings Effectively?

KT&G has a high three-year median payout ratio of 66% (or a retention ratio of 34%), 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.

Additionally, KT&G 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. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 58%. Accordingly, forecasts suggest that KT&G's future ROE will be 12% which is again, similar to the current ROE.

Conclusion

In total, we would have a hard think before deciding on any investment action concerning KT&G. Because the company is not reinvesting much into the business, and given the low ROE, it's not surprising to see the lack or absence of growth in its earnings. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.