Kaori Heat Treatment Co., Ltd.'s (TPE:8996) Has Been On A Rise But Financial Prospects Look Weak: Is The Stock Overpriced?

Kaori Heat Treatment (TPE:8996) has had a great run on the share market with its stock up by a significant 9.1% over the last month. However, in this article, we decided to focus on its weak fundamentals, as long-term financial performance of a business is what ultimatley dictates market outcomes. Specifically, we decided to study Kaori Heat Treatment'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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

View our latest analysis for Kaori Heat Treatment

How Do You Calculate Return On Equity?

Return on equity can be calculated by using the formula:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Kaori Heat Treatment is:

5.4% = NT$99m ÷ NT$1.8b (Based on the trailing twelve months to September 2020).

The 'return' is the income the business earned over the last year. Another way to think of that is that for every NT$1 worth of equity, the company was able to earn NT$0.05 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. 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 Kaori Heat Treatment's Earnings Growth And 5.4% ROE

On the face of it, Kaori Heat Treatment's ROE is not much to talk about. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 9.9%. Given the circumstances, the significant decline in net income by 8.2% seen by Kaori Heat Treatment over the last five years is not surprising. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. For example, it is possible that the business has allocated capital poorly or that the company has a very high payout ratio.

That being said, we compared Kaori Heat Treatment'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 1.2% in the same period.

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Kaori Heat Treatment's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Kaori Heat Treatment Efficiently Re-investing Its Profits?

Kaori Heat Treatment's very high three-year median payout ratio of 110% over the last three years suggests that the company is paying its shareholders more than what it is earning and this explains the company's shrinking earnings. Paying a dividend higher than reported profits is not a sustainable move. To know the 5 risks we have identified for Kaori Heat Treatment visit our risks dashboard for free.

In addition, Kaori Heat Treatment 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.

Conclusion

In total, we would have a hard think before deciding on any investment action concerning Kaori Heat Treatment. Specifically, it has shown quite an unsatisfactory performance as far as earnings growth is concerned, and a poor ROE and an equally poor rate of reinvestment seem to be the reason behind this inadequate performance. Up till now, we've only made a short study of the company's growth data. You can do your own research on Kaori Heat Treatment and see how it has performed in the past by looking at this FREE detailed graph of past earnings, revenue and cash flows.

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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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