Kuobrothers (GTSM:8477) has had a rough three months with its share price down 16%. 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 Kuobrothers' ROE in this article.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
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 Kuobrothers is:
7.8% = NT$42m ÷ NT$534m (Based on the trailing twelve months to September 2020).
The 'return' refers to a company's earnings over the last year. That means that for every NT$1 worth of shareholders' equity, the company generated NT$0.08 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. 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.
A Side By Side comparison of Kuobrothers' Earnings Growth And 7.8% ROE
When you first look at it, Kuobrothers' ROE doesn't look that attractive. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 10.0% either. For this reason, Kuobrothers' five year net income decline of 3.2% is not surprising given its lower ROE. However, there could also be other factors causing the earnings to decline. Such as - low earnings retention or poor allocation of capital.
With the industry earnings declining at a rate of 3.2% in the same period, we deduce that both the company and the industry are shrinking at the same rate.
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. Doing so will help them establish if the stock's future looks promising or ominous. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Kuobrothers is trading on a high P/E or a low P/E, relative to its industry.
Is Kuobrothers Making Efficient Use Of Its Profits?
Kuobrothers has a high three-year median payout ratio of 89% (that is, it is retaining 11% 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. The business is only left with a small pool of capital to reinvest - A vicious cycle that doesn't benefit the company in the long-run. To know the 3 risks we have identified for Kuobrothers visit our risks dashboard for free.
Additionally, Kuobrothers has paid dividends over a period of five years, which means that the company's management is rather focused on keeping up its dividend payments, regardless of the shrinking earnings.
In total, we would have a hard think before deciding on any investment action concerning Kuobrothers. As a result of its low ROE and lack of mich reinvestment into the business, the company has seen a disappointing earnings growth rate. Up till now, we've only made a short study of the company's growth data. You can do your own research on Kuobrothers 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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