Kossan Rubber Industries Bhd's (KLSE:KOSSAN) Fundamentals Look Pretty Strong: Could The Market Be Wrong About The Stock?

Kossan Rubber Industries Bhd (KLSE:KOSSAN) has had a rough three months with its share price down 39%. However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. In this article, we decided to focus on Kossan Rubber Industries Bhd's ROE.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for Kossan Rubber Industries Bhd

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 Kossan Rubber Industries Bhd is:

31% = RM610m ÷ RM2.0b (Based on the trailing twelve months to September 2020).

The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each MYR1 of shareholders' capital it has, the company made MYR0.31 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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.

Kossan Rubber Industries Bhd's Earnings Growth And 31% ROE

Firstly, we acknowledge that Kossan Rubber Industries Bhd has a significantly high ROE. However, a comparison to the industry average of 44% stops us from getting too excited. However, the moderate 15% net income growth seen by Kossan Rubber Industries Bhd over the past five years is a positive. Therefore, the growth in earnings could probably have been caused by other variables. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio. However, not to forget, the company does have a high ROE to begin with, just that it is lower than the industry average. So the high ROE levels also provide some context to the earnings growth seen by the company.

We then compared Kossan Rubber Industries Bhd's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 37% 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. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. 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?

With a three-year median payout ratio of 36% (implying that the company retains 64% of its profits), it seems that Kossan Rubber Industries Bhd is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.

Additionally, Kossan Rubber Industries Bhd has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 49% over the next three years. However, Kossan Rubber Industries Bhd's future ROE is expected to rise to 40% despite the expected increase in the company's payout ratio. We infer that there could be other factors that could be driving the anticipated growth in the company's ROE.

Summary

On the whole, we do feel that Kossan Rubber Industries Bhd has some positive attributes. In particular, it's great to see that the company is investing heavily into its business and along with a moderate rate of return, that has resulted in a respectable growth in its earnings. That being so, according to the latest industry analyst forecasts, the company's earnings are expected to shrink in the future. 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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