Does TECO Electric & Machinery Co., Ltd.'s (TPE:1504) Weak Fundamentals Mean A Downturn In Its Stock Should Be Expected?

TECO Electric & Machinery's (TPE:1504) stock is up by 9.5% over the past three months. However, its weak financial performance indicators makes us a bit doubtful if that trend could continue. Specifically, we decided to study TECO Electric & Machinery's ROE in this article.

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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for TECO Electric & Machinery

How Is ROE Calculated?

ROE can be calculated by using the formula:

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

So, based on the above formula, the ROE for TECO Electric & Machinery is:

5.3% = NT$3.6b ÷ NT$67b (Based on the trailing twelve months to September 2020).

The 'return' is the profit over the last twelve months. So, this means that for every NT$1 of its shareholder's investments, the company generates a profit of NT$0.05.

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 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.

TECO Electric & Machinery's Earnings Growth And 5.3% ROE

On the face of it, TECO Electric & Machinery's ROE is not much to talk about. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 8.1%. Therefore, TECO Electric & Machinery's flat earnings over the past five years can possibly be explained by the low ROE amongst other factors.

As a next step, we compared TECO Electric & Machinery's net income growth with the industry and discovered that the industry saw an average growth of 3.7% in the same period.

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if TECO Electric & Machinery is trading on a high P/E or a low P/E, relative to its industry.

Is TECO Electric & Machinery Using Its Retained Earnings Effectively?

TECO Electric & Machinery has a high three-year median payout ratio of 55% (or a retention ratio of 45%), meaning that the company is paying most of its profits as dividends to its shareholders. This does go some way in explaining why there's been no growth in its earnings.

Moreover, TECO Electric & Machinery has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over 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 62%. Accordingly, forecasts suggest that TECO Electric & Machinery's future ROE will be 5.4% which is again, similar to the current ROE.

Conclusion

Overall, we would be extremely cautious before making any decision on TECO Electric & Machinery. As a result of its low ROE and lack of mich reinvestment into the business, the company has seen a disappointing earnings growth rate. 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. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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