Can Mixed Fundamentals Have A Negative Impact on ILJIN Materials Co., Ltd. (KRX:020150) Current Share Price Momentum?

ILJIN Materials' (KRX:020150) stock is up by a considerable 13% over the past three months. But the company's key financial indicators appear to be differing across the board and that makes us question whether or not the company's current share price momentum can be maintained. In this article, we decided to focus on ILJIN Materials' ROE.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for ILJIN Materials

How Do You 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 ILJIN Materials is:

5.2% = ₩44b ÷ ₩860b (Based on the trailing twelve months to September 2020).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each ₩1 of shareholders' capital it has, the company made ₩0.05 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. 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. 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.

ILJIN Materials' Earnings Growth And 5.2% ROE

It is hard to argue that ILJIN Materials' ROE is much good in and of itself. An industry comparison shows that the company's ROE is not much different from the industry average of 5.3% either. ILJIN Materials' flat earnings over the past five years can possibly be explained by the low ROE amongst other factors.

We then compared ILJIN Materials' net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 2.3% in the same period, which is a bit concerning.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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 ILJIN Materials is trading on a high P/E or a low P/E, relative to its industry.

Is ILJIN Materials Using Its Retained Earnings Effectively?

ILJIN Materials' low three-year median payout ratio of 4.9% (implying that the company keeps95% 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, ILJIN Materials 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. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 2.9% over the next three years. As a result, the expected drop in ILJIN Materials' payout ratio explains the anticipated rise in the company's future ROE to 14%, over the same period.

Summary

Overall, we have mixed feelings about ILJIN Materials. 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. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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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