Should Weakness in Tech-Top Engineering CO., LTD's (GTSM:6750) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?

With its stock down 3.8% over the past three months, it is easy to disregard Tech-Top Engineering (GTSM:6750). However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. In this article, we decided to focus on Tech-Top Engineering's ROE.

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.

Check out our latest analysis for Tech-Top Engineering

How Is ROE Calculated?

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 Tech-Top Engineering is:

8.0% = NT$24m ÷ NT$306m (Based on the trailing twelve months to June 2020).

The 'return' refers to a company's earnings over the last year. So, this means that for every NT$1 of its shareholder's investments, the company generates a profit of NT$0.08.

What Is The Relationship Between ROE And 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. 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 Tech-Top Engineering's Earnings Growth And 8.0% ROE

When you first look at it, Tech-Top Engineering's ROE doesn't look that attractive. Yet, a closer study shows that the company's ROE is similar to the industry average of 9.4%. Moreover, we are quite pleased to see that Tech-Top Engineering's net income grew significantly at a rate of 50% over the last five years. Given the slightly low ROE, it is likely that there could be some other aspects that are driving this growth. For instance, the company has a low payout ratio or is being managed efficiently.

Next, on comparing with the industry net income growth, we found that Tech-Top Engineering's growth is quite high when compared to the industry average growth of 19% in the same period, which is great to see.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. Is Tech-Top Engineering fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Tech-Top Engineering Using Its Retained Earnings Effectively?

Tech-Top Engineering's three-year median payout ratio is a pretty moderate 42%, meaning the company retains 58% of its income. So it seems that Tech-Top Engineering is reinvesting efficiently in a way that it sees impressive growth in its earnings (discussed above) and pays a dividend that's well covered.

While Tech-Top Engineering has been growing its earnings, it only recently started to pay dividends which likely means that the company decided to impress new and existing shareholders with a dividend.

Conclusion

In total, it does look like Tech-Top Engineering has some positive aspects to its business. Despite its low rate of return, the fact that the company reinvests a very high portion of its profits into its business, no doubt contributed to its high earnings growth. 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. Our risks dashboard would have the 5 risks we have identified for Tech-Top Engineering.

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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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