Are Kossan Rubber Industries Bhd's (KLSE:KOSSAN) Mixed Financials The Reason For Its Gloomy Performance on The Stock Market?

It is hard to get excited after looking at Kossan Rubber Industries Bhd's (KLSE:KOSSAN) recent performance, when its stock has declined 9.8% over the past week. It seems that the market might have completely ignored the positive aspects of the company's fundamentals and decided to weigh-in more on the negative aspects. Stock prices are usually driven by a company’s financial performance over the long term, and therefore we decided to pay more attention to the company's financial performance. Particularly, we will be paying attention to Kossan Rubber Industries Bhd's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

Check out our latest analysis for Kossan Rubber Industries Bhd

How To 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 Kossan Rubber Industries Bhd is:

1.8% = RM72m ÷ RM3.9b (Based on the trailing twelve months to March 2024).

The 'return' is the income the business earned over the last year. So, this means that for every MYR1 of its shareholder's investments, the company generates a profit of MYR0.02.

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.

A Side By Side comparison of Kossan Rubber Industries Bhd's Earnings Growth And 1.8% ROE

It is hard to argue that Kossan Rubber Industries Bhd's ROE is much good in and of itself. Even compared to the average industry ROE of 8.6%, the company's ROE is quite dismal. Given the circumstances, the significant decline in net income by 6.5% seen by Kossan Rubber Industries Bhd over the last five years is not surprising. We reckon that there could also be other factors at play here. For example, the business has allocated capital poorly, or that the company has a very high payout ratio.

That being said, we compared Kossan Rubber Industries Bhd'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 9.1% in the same 5-year 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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Kossan Rubber Industries Bhd fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Kossan Rubber Industries Bhd Efficiently Re-investing Its Profits?

In spite of a normal three-year median payout ratio of 48% (that is, a retention ratio of 52%), the fact that Kossan Rubber Industries Bhd's earnings have shrunk is quite puzzling. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.

Additionally, Kossan Rubber Industries Bhd has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 40% of its profits over the next three years. Still, forecasts suggest that Kossan Rubber Industries Bhd's future ROE will rise to 5.5% even though the the company's payout ratio is not expected to change by much.

Summary

In total, we're a bit ambivalent about Kossan Rubber Industries Bhd's performance. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the earnings growth. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com