Songwon Industrial Co., Ltd.'s (KRX:004430) Stock Is Rallying But Financials Look Ambiguous: Will The Momentum Continue?

Songwon Industrial (KRX:004430) has had a great run on the share market with its stock up by a significant 23% over the last three months. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. In this article, we decided to focus on Songwon 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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Songwon Industrial

How Is ROE Calculated?

Return on equity can be calculated by using the formula:

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

So, based on the above formula, the ROE for Songwon Industrial is:

6.9% = ₩31b ÷ ₩457b (Based on the trailing twelve months to September 2020).

The 'return' is the yearly profit. Another way to think of that is that for every ₩1 worth of equity, the company was able to earn ₩0.07 in profit.

Why Is ROE Important For 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 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.

A Side By Side comparison of Songwon Industrial's Earnings Growth And 6.9% ROE

At first glance, Songwon Industrial's ROE doesn't look very promising. Yet, a closer study shows that the company's ROE is similar to the industry average of 7.9%. Still, Songwon Industrial has seen a flat net income growth over the past five years. Remember, the company's ROE is not particularly great to begin with. So that could also be one of the reasons behind the company's flat growth in earnings.

Next, on comparing with the industry net income growth, we found that the industry grew its earnings by7.6% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. Is Songwon Industrial fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Songwon Industrial Making Efficient Use Of Its Profits?

Songwon Industrial's low three-year median payout ratio of 11% (implying that the company keeps89% of its income) should mean that the company is retaining most of its earnings to fuel its growth and this should be reflected in its growth number, but that's not the case.

Moreover, Songwon Industrial has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 5.7% over the next three years. As a result, the expected drop in Songwon Industrial's payout ratio explains the anticipated rise in the company's future ROE to 12%, over the same period.

Conclusion

Overall, we have mixed feelings about Songwon 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. 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. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

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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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