Will Weakness in Korean Air Lines Co., Ltd.'s (KRX:003490) Stock Prove Temporary Given Strong Fundamentals?

Korean Air Lines (KRX:003490) has had a rough week with its share price down 3.4%. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Specifically, we decided to study Korean Air Lines' ROE in this article.

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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for Korean Air Lines

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 Korean Air Lines is:

14% = ₩1.4t ÷ ₩10t (Based on the trailing twelve months to September 2023).

The 'return' is the income the business earned over the last year. So, this means that for every ₩1 of its shareholder's investments, the company generates a profit of ₩0.14.

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. 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.

Korean Air Lines' Earnings Growth And 14% ROE

To begin with, Korean Air Lines seems to have a respectable ROE. Yet, the fact that the company's ROE is lower than the industry average of 36% does temper our expectations. That being the case, the significant five-year 59% net income growth reported by Korean Air Lines comes as a pleasant surprise. Therefore, there could be other causes behind this growth. Such as - high earnings retention or an efficient management in place. However, not to forget, the company does have a decent ROE to begin with, just that it is lower than the industry average. So this certainly also provides some context to the high earnings growth seen by the company.

We then compared Korean Air Lines' net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 25% in the same 5-year 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. What is A003490 worth today? The intrinsic value infographic in our free research report helps visualize whether A003490 is currently mispriced by the market.

Is Korean Air Lines Making Efficient Use Of Its Profits?

Korean Air Lines' ' three-year median payout ratio is on the lower side at 20% implying that it is retaining a higher percentage (80%) of its profits. So it looks like Korean Air Lines is reinvesting profits heavily to grow its business, which shows in its earnings growth.

Besides, Korean Air Lines has been paying dividends over a period of five years. This shows that the company is committed to sharing profits with its shareholders. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 24% over the next three years. Therefore, the expected rise in the payout ratio explains why the company's ROE is expected to decline to 10% over the same period.

Conclusion

In total, we are pretty happy with Korean Air Lines' performance. Particularly, we like that the company is reinvesting heavily into its business at a moderate rate of return. Unsurprisingly, this has led to an impressive earnings growth. Having said that, on studying current analyst estimates, we were concerned to see that while the company has grown its earnings in the past, analysts expect its earnings to shrink in the future. 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. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.