Hwa Fong Rubber Ind. Co., Ltd.'s (TPE:2109) Stock Has Seen Strong Momentum: Does That Call For Deeper Study Of Its Financial Prospects?

Hwa Fong Rubber Ind (TPE:2109) has had a great run on the share market with its stock up by a significant 8.8% over the last month. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. Particularly, we will be paying attention to Hwa Fong Rubber Ind's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.

View our latest analysis for Hwa Fong Rubber Ind

How Do You Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Hwa Fong Rubber Ind is:

10% = NT$436m ÷ NT$4.2b (Based on the trailing twelve months to September 2020).

The 'return' is the yearly profit. That means that for every NT$1 worth of shareholders' equity, the company generated NT$0.10 in profit.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.

Hwa Fong Rubber Ind's Earnings Growth And 10% ROE

To begin with, Hwa Fong Rubber Ind seems to have a respectable ROE. Especially when compared to the industry average of 5.1% the company's ROE looks pretty impressive. For this reason, Hwa Fong Rubber Ind's five year net income decline of 19% raises the question as to why the high ROE didn't translate into earnings growth. Therefore, there might be some other aspects that could explain this. These include low earnings retention or poor allocation of capital.

As a next step, we compared Hwa Fong Rubber Ind's performance with the industry and found thatHwa Fong Rubber Ind's performance is depressing even when compared with the industry, which has shrunk its earnings at a rate of 11% in the same period, which is a slower than the company.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Hwa Fong Rubber Ind's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Hwa Fong Rubber Ind Using Its Retained Earnings Effectively?

Because Hwa Fong Rubber Ind doesn't pay any dividends, we infer that it is retaining all of its profits, which is rather perplexing when you consider the fact that there is no earnings growth to show for it. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Conclusion

Overall, we feel that Hwa Fong Rubber Ind certainly does have some positive factors to consider. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. To know the 2 risks we have identified for Hwa Fong Rubber Ind visit our risks dashboard for free.

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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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