Union Community Co., Ltd.'s (KOSDAQ:203450) Stock Has Seen Strong Momentum: Does That Call For Deeper Study Of Its Financial Prospects?

Most readers would already be aware that Union Community's (KOSDAQ:203450) stock increased significantly by 44% over the past three months. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. In this article, we decided to focus on Union Community's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.

View our latest analysis for Union Community

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 Union Community is:

7.0% = ₩2.5b ÷ ₩35b (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 ₩0.07 in profit.

What Is The Relationship Between ROE And 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 Union Community's Earnings Growth And 7.0% ROE

When you first look at it, Union Community's ROE doesn't look that attractive. Although a closer study shows that the company's ROE is higher than the industry average of 5.4% which we definitely can't overlook. Yet, Union Community has posted measly growth of 2.5% over the past five years. Remember, the company's ROE is quite low to begin with, just that it is higher than the industry average. Therefore, the low growth in earnings could also be the result of this.

We then performed a comparison between Union Community's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 2.3% in the same period.

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). 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 Union Community is trading on a high P/E or a low P/E, relative to its industry.

Is Union Community Efficiently Re-investing Its Profits?

Despite having a normal three-year median payout ratio of 29% (or a retention ratio of 71% over the past three years, Union Community has seen very little growth in earnings as we saw above. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

Only recently, Union Community started paying a dividend. This means that the management might have concluded that its shareholders prefer dividends over earnings growth.

Conclusion

On the whole, we do feel that Union Community has some positive attributes. Specifically, we like that the company is reinvesting a huge chunk of its profits at a respectable rate of return. This of course has caused the company to see a good amount of 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 5 risks we have identified for Union Community 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. 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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