ABC Taiwan Electronics‘ (GTSM:3236) stock is up by a considerable 6.6% over the past month. But the company’s key financial indicators appear to be differing across the board and that makes us question whether or not the company’s current share price momentum can be maintained. In this article, we decided to focus on ABC Taiwan Electronics’ ROE.
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 other words, it is a profitability ratio that measures the rate of return on the capital provided by the company’s shareholders.
How To Calculate Return On Equity?
ROE 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 ABC Taiwan Electronics is:
5.6% = NT$74m ÷ NT$1.3b (Based on the trailing twelve months to December 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$0.06 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 ABC Taiwan Electronics’ Earnings Growth And 5.6% ROE
When you first look at it, ABC Taiwan Electronics‘ ROE doesn’t look that attractive. 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 10%. Therefore, it might not be wrong to say that the five-year net income decline of 14% seen by ABC Taiwan Electronics was probably the result of it having a lower ROE. We reckon that there could also be other factors at play here. For instance, the company has a very high payout ratio or is faced with competitive pressures.
However, when we compared ABC Taiwan Electronics’ growth with the industry we found that while the company’s earnings have been shrinking, the industry has seen an earnings growth of 9.0% 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 ABC Taiwan Electronics fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is ABC Taiwan Electronics Making Efficient Use Of Its Profits?
When we piece together ABC Taiwan Electronics’ low three-year median payout ratio of 23% (where it is retaining 77% of its profits), calculated for the last three-year period, we are puzzled by the lack of growth. This typically shouldn’t be the case when a company is retaining most of its earnings. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.
Additionally, ABC Taiwan Electronics has paid dividends over a period of at least ten years, which means that the company’s management is determined to pay dividends even if it means little to no earnings growth.
In total, we’re a bit ambivalent about ABC Taiwan Electronics’ performance. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. Our risks dashboard would have the 4 risks we have identified for ABC Taiwan Electronics.