Does Kuo Yang Construction Co.,Ltd's (TWSE:2505) Weak Fundamentals Mean That The Market Could Correct Its Share Price?

Kuo Yang ConstructionLtd's (TWSE:2505) stock is up by a considerable 42% over the past three months. We, however wanted to have a closer look at its key financial indicators as the markets usually pay for long-term fundamentals, and in this case, they don't look very promising. In this article, we decided to focus on Kuo Yang ConstructionLtd's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for Kuo Yang ConstructionLtd

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 Kuo Yang ConstructionLtd is:

3.0% = NT$305m ÷ NT$10b (Based on the trailing twelve months to December 2023).

The 'return' is the yearly profit. Another way to think of that is that for every NT$1 worth of equity, the company was able to earn NT$0.03 in profit.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 Kuo Yang ConstructionLtd's Earnings Growth And 3.0% ROE

At first glance, Kuo Yang ConstructionLtd's ROE doesn't look very promising. Next, when compared to the average industry ROE of 8.9%, the company's ROE leaves us feeling even less enthusiastic. Given the circumstances, the significant decline in net income by 11% seen by Kuo Yang ConstructionLtd over the last five years is not surprising. We reckon that there could also be other factors at play here. Such as - low earnings retention or poor allocation of capital.

However, when we compared Kuo Yang ConstructionLtd's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 5.0% in the same period. This is quite worrisome.

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 Kuo Yang ConstructionLtd fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Kuo Yang ConstructionLtd Using Its Retained Earnings Effectively?

With a high three-year median payout ratio of 65% (implying that 35% of the profits are retained), most of Kuo Yang ConstructionLtd's profits are being paid to shareholders, which explains the company's shrinking earnings. With only a little being reinvested into the business, earnings growth would obviously be low or non-existent.

Moreover, Kuo Yang ConstructionLtd has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth.

Conclusion

Overall, we would be extremely cautious before making any decision on Kuo Yang ConstructionLtd. As a result of its low ROE and lack of much reinvestment into the business, the company has seen a disappointing earnings growth rate. So far, we've only made a quick discussion around the company's earnings growth. To gain further insights into Kuo Yang ConstructionLtd's past profit growth, check out this visualization of past earnings, revenue and cash flows.

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

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.