YIK's (KOSDAQ:232140) stock is up by a considerable 22% over the past month. 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. In this article, we decided to focus on YIK's ROE.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
How Do You Calculate Return On Equity?
ROE 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 YIK is:
5.8% = ₩12b ÷ ₩201b (Based on the trailing twelve months to September 2020).
The 'return' is the yearly profit. One way to conceptualize this is that for each ₩1 of shareholders' capital it has, the company made ₩0.06 in profit.
Why Is ROE Important For 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.
A Side By Side comparison of YIK's Earnings Growth And 5.8% ROE
On the face of it, YIK's ROE is not much to talk about. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 8.5% either. Therefore, it might not be wrong to say that the five year net income decline of 34% seen by YIK was probably the result of it having a lower ROE. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. Such as - low earnings retention or poor allocation of capital.
That being said, we compared YIK'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 12% 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. Is YIK fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is YIK Making Efficient Use Of Its Profits?
On the whole, we feel that the performance shown by YIK can be open to many interpretations. 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. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. You can see the 2 risks we have identified for YIK by visiting our risks dashboard for free on our platform here.
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