StrongLED Lighting Systems (Cayman) Co., Ltd.'s (GTSM:5281) Financials Are Too Obscure To Link With Current Share Price Momentum: What's In Store For the Stock?

Most readers would already be aware that StrongLED Lighting Systems (Cayman)'s (GTSM:5281) stock increased significantly by 17% 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. Specifically, we decided to study StrongLED Lighting Systems (Cayman)'s 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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for StrongLED Lighting Systems (Cayman)

How To 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 StrongLED Lighting Systems (Cayman) is:

7.0% = NT$61m ÷ NT$870m (Based on the trailing twelve months to September 2020).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every NT$1 worth of equity, the company was able to earn NT$0.07 in profit.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 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 StrongLED Lighting Systems (Cayman)'s Earnings Growth And 7.0% ROE

When you first look at it, StrongLED Lighting Systems (Cayman)'s ROE doesn't look that attractive. However, given that the company's ROE is similar to the average industry ROE of 7.9%, we may spare it some thought. Having said that, StrongLED Lighting Systems (Cayman)'s five year net income decline rate was 11%. Bear in mind, the company does have a slightly low ROE. So that's what might be causing earnings growth to shrink.

However, when we compared StrongLED Lighting Systems (Cayman)'s growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 3.7% in the same period. This is quite worrisome.

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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is StrongLED Lighting Systems (Cayman) fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is StrongLED Lighting Systems (Cayman) Efficiently Re-investing Its Profits?

Looking at its three-year median payout ratio of 30% (or a retention ratio of 70%) which is pretty normal, StrongLED Lighting Systems (Cayman)'s declining earnings is rather baffling as one would expect to see a fair bit of growth when a company is retaining a good portion of its profits. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

In addition, StrongLED Lighting Systems (Cayman) has been paying dividends over a period of four years suggesting that keeping up dividend payments is preferred by the management even though earnings have been in decline.

Conclusion

In total, we're a bit ambivalent about StrongLED Lighting Systems (Cayman)'s 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 2 risks we have identified for StrongLED Lighting Systems (Cayman).

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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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