Does Fu Chian Tire Co.,Ltd.'s (GTSM:5102) Weak Fundamentals Mean A Downturn In Its Stock Should Be Expected?

Fu Chian TireLtd's (GTSM:5102) stock up by 1.6% over the past three months. Given that the markets usually pay for the long-term financial health of a company, we wonder if the current momentum in the share price will keep up, given that the company's financials don't look very promising. In this article, we decided to focus on Fu Chian TireLtd's ROE.

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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for Fu Chian TireLtd

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 Fu Chian TireLtd is:

4.5% = NT$44m ÷ NT$984m (Based on the trailing twelve months to September 2020).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each NT$1 of shareholders' capital it has, the company made NT$0.05 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.

Fu Chian TireLtd's Earnings Growth And 4.5% ROE

When you first look at it, Fu Chian TireLtd's ROE doesn't look that attractive. Yet, a closer study shows that the company's ROE is similar to the industry average of 5.1%. But Fu Chian TireLtd saw a five year net income decline of 5.2% over the past five years. Remember, the company's ROE is a bit low to begin with. Therefore, the decline in earnings could also be the result of this.

As a next step, we compared Fu Chian TireLtd's performance with the industry and discovered the industry has shrunk at a rate of 11% in the same period meaning that the company has been shrinking its earnings at a rate lower than the industry. This does appease the negative sentiment around the company to a certain extent.

Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Fu Chian TireLtd's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Fu Chian TireLtd Using Its Retained Earnings Effectively?

Fu Chian TireLtd has a high three-year median payout ratio of 86% (that is, it is retaining 14% 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. With only a little being reinvested into the business, earnings growth would obviously be low or non-existent. Our risks dashboard should have the 4 risks we have identified for Fu Chian TireLtd.

Additionally, Fu Chian TireLtd 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.

Summary

On the whole, Fu Chian TireLtd's performance is quite a big let-down. 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. Up till now, we've only made a short study of the company's growth data. To gain further insights into Fu Chian TireLtd's past profit growth, check out this visualization of past earnings, revenue and cash flows.

If you’re looking to trade Fu Chian TireLtd, open an account with the lowest-cost* platform trusted by professionals, Interactive Brokers. Their clients from over 200 countries and territories trade stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

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