Kossan Rubber Industries Bhd (KLSE:KOSSAN) Stock's On A Decline: Are Poor Fundamentals The Cause?

Kossan Rubber Industries Bhd (KLSE:KOSSAN) has had a rough month with its share price down 14%. Given that stock prices are usually driven by a company’s fundamentals over the long term, which in this case look pretty weak, we decided to study the company's key financial indicators. Specifically, we decided to study Kossan Rubber Industries Bhd's 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. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for Kossan Rubber Industries Bhd

How To Calculate Return On Equity?

The formula for ROE 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:

2.5% = RM95m ÷ RM3.9b (Based on the trailing twelve months to September 2024).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every MYR1 of its shareholder's investments, the company generates a profit of MYR0.02.

What Has ROE Got To Do With 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. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

Kossan Rubber Industries Bhd's Earnings Growth And 2.5% ROE

It is quite clear that Kossan Rubber Industries Bhd's ROE is rather low. Even when compared to the industry average of 8.0%, the ROE figure is pretty disappointing. For this reason, Kossan Rubber Industries Bhd's five year net income decline of 24% is not surprising given its lower ROE. We reckon that there could also be other factors at play here. Such as - low earnings retention or poor allocation of capital.

So, as a next step, we compared Kossan Rubber Industries Bhd's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 8.0% over the last few years.

Earnings growth is a huge factor in stock valuation. 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. Is Kossan Rubber Industries Bhd fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Kossan Rubber Industries Bhd Using Its Retained Earnings Effectively?

Kossan Rubber Industries Bhd has a high three-year median payout ratio of 81% (that is, it is retaining 19% of its profits). This suggests that the company is paying most of its profits as dividends to its shareholders. This goes some way in explaining why its earnings have been shrinking. With only a little being reinvested into the business, earnings growth would obviously be low or non-existent.

In addition, Kossan Rubber Industries Bhd has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 50% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 5.8%, over the same period.

Conclusion

In total, we would have a hard think before deciding on any investment action concerning Kossan Rubber Industries Bhd. Because the company is not reinvesting much into the business, and given the low ROE, it's not surprising to see the lack or absence of growth in its earnings. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. 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. 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.