SK Chemicals Co.,Ltd. (KRX:285130) Stock Is Going Strong But Fundamentals Look Uncertain: What Lies Ahead ?

Most readers would already be aware that SK ChemicalsLtd's (KRX:285130) stock increased significantly by 29% over the past three months. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. Specifically, we decided to study SK ChemicalsLtd'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. Put another way, it reveals the company's success at turning shareholder investments into profits.

View our latest analysis for SK ChemicalsLtd

How Is ROE Calculated?

The formula for ROE is:

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

So, based on the above formula, the ROE for SK ChemicalsLtd is:

6.7% = ₩67b ÷ ₩997b (Based on the trailing twelve months to September 2020).

The 'return' is the yearly profit. That means that for every ₩1 worth of shareholders' equity, the company generated ₩0.07 in profit.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.

SK ChemicalsLtd's Earnings Growth And 6.7% ROE

When you first look at it, SK ChemicalsLtd's ROE doesn't look that attractive. However, given that the company's ROE is similar to the average industry ROE of 8.1%, we may spare it some thought. But then again, SK ChemicalsLtd's five year net income shrunk at a rate of 16%. Bear in mind, the company does have a slightly low ROE. Therefore, the decline in earnings could also be the result of this.

That being said, we compared SK ChemicalsLtd's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 7.7% in the same period.

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. Doing so will help them establish if the stock's future looks promising or ominous. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if SK ChemicalsLtd is trading on a high P/E or a low P/E, relative to its industry.

Is SK ChemicalsLtd Using Its Retained Earnings Effectively?

SK ChemicalsLtd's low three-year median payout ratio of 15% (or a retention ratio of 85%) over the last three years should mean that the company is retaining most of its earnings to fuel its growth but the company's earnings have actually shrunk. This typically shouldn't be the case when a company is retaining most of its earnings. So there might be other factors at play here which could potentially be hampering growth. For instance, the business has faced some headwinds.

Additionally, SK ChemicalsLtd started paying a dividend only recently. So it looks like the management may have perceived that shareholders favor dividends even though earnings have been in decline. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 3.1% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 13%, over the same period.

Summary

Overall, we have mixed feelings about SK ChemicalsLtd. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. Having said that, we studied the latest analyst forecasts, and found that analysts are expecting the company's earnings growth to improve slightly. The company's existing shareholders might have some respite after all. 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. 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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