Korea Petroleum Industries Company's (KRX:004090) Stock Has Shown Weakness Lately But Financial Prospects Look Decent: Is The Market Wrong?

Korea Petroleum Industries (KRX:004090) has had a rough month with its share price down 14%. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Particularly, we will be paying attention to Korea Petroleum Industries' ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Korea Petroleum Industries

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 Korea Petroleum Industries is:

8.4% = ₩15b ÷ ₩177b (Based on the trailing twelve months to March 2024).

The 'return' is the yearly profit. One way to conceptualize this is that for each ₩1 of shareholders' capital it has, the company made ₩0.08 in profit.

What Has ROE Got To Do With 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

Korea Petroleum Industries' Earnings Growth And 8.4% ROE

When you first look at it, Korea Petroleum Industries' ROE doesn't look that attractive. However, its ROE is similar to the industry average of 8.4%, so we won't completely dismiss the company. Moreover, we are quite pleased to see that Korea Petroleum Industries' net income grew significantly at a rate of 40% over the last five years. Considering the moderately low ROE, it is quite possible that there might be some other aspects that are positively influencing the company's earnings growth. For instance, the company has a low payout ratio or is being managed efficiently.

Next, on comparing with the industry net income growth, we found that Korea Petroleum Industries' growth is quite high when compared to the industry average growth of 24% in the same period, which is great to see.

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. If you're wondering about Korea Petroleum Industries''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Korea Petroleum Industries Using Its Retained Earnings Effectively?

Korea Petroleum Industries' three-year median payout ratio to shareholders is 9.8%, which is quite low. This implies that the company is retaining 90% of its profits. This suggests that the management is reinvesting most of the profits to grow the business as evidenced by the growth seen by the company.

Additionally, Korea Petroleum Industries has paid dividends over a period of five years which means that the company is pretty serious about sharing its profits with shareholders. 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 8.8%. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 9.3%.

Conclusion

On the whole, we do feel that Korea Petroleum Industries has some positive attributes. 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. You can see the 2 risks we have identified for Korea Petroleum Industries 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. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com