ASM Pacific Technology Limited's (HKG:522) Stock's Been Going Strong: Could Weak Financials Mean The Market Will Coorect Its Share Price?

ASM Pacific Technology's (HKG:522) stock is up by a considerable 28% over the past three months. 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. Particularly, we will be paying attention to ASM Pacific Technology's ROE today.

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. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for ASM Pacific Technology

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 ASM Pacific Technology is:

7.3% = HK$847m ÷ HK$12b (Based on the trailing twelve months to September 2020).

The 'return' is the yearly profit. That means that for every HK$1 worth of shareholders' equity, the company generated HK$0.07 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. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

A Side By Side comparison of ASM Pacific Technology's Earnings Growth And 7.3% ROE

When you first look at it, ASM Pacific Technology's ROE doesn't look that attractive. However, given that the company's ROE is similar to the average industry ROE of 7.4%, we may spare it some thought. But then again, ASM Pacific Technology's five year net income shrunk at a rate of 5.2%. Remember, the company's ROE is a bit low to begin with. Therefore, the decline in earnings could also be the result of this.

So, as a next step, we compared ASM Pacific Technology's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 8.5% in the same period.

Earnings growth is a huge factor in stock valuation. 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 ASM Pacific Technology fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is ASM Pacific Technology Making Efficient Use Of Its Profits?

ASM Pacific Technology's declining earnings is not surprising given how the company is spending most of its profits in paying dividends, judging by its three-year median payout ratio of 59% (or a retention ratio of 41%). With only a little being reinvested into the business, earnings growth would obviously be low or non-existent.

Additionally, ASM Pacific Technology 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. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 54%. Regardless, the future ROE for ASM Pacific Technology is predicted to rise to 16% despite there being not much change expected in its payout ratio.

Summary

Overall, we would be extremely cautious before making any decision on ASM Pacific Technology. The company has seen a lack of earnings growth as a result of retaining very little profits and whatever little it does retain, is being reinvested at a very low rate of return. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow 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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