Are Falcon Power Co., Ltd.'s (TPE:1516) Mixed Financials Driving The Negative Sentiment?

Falcon Power (TPE:1516) has had a rough month with its share price down 8.8%. It is possible that the markets have ignored the company's differing financials and decided to lean-in to the negative sentiment. Fundamentals usually dictate market outcomes so it makes sense to study the company's financials. In this article, we decided to focus on Falcon Power's ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

See our latest analysis for Falcon Power

How To Calculate Return On Equity?

Return on equity 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 Falcon Power is:

7.0% = NT$28m ÷ NT$402m (Based on the trailing twelve months to September 2020).

The 'return' refers to a company's earnings over the last year. 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.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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. 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 Falcon Power's Earnings Growth And 7.0% ROE

On the face of it, Falcon Power's ROE is not much to talk about. Yet, a closer study shows that the company's ROE is similar to the industry average of 7.9%. But then again, Falcon Power's five year net income shrunk at a rate of 22%. Remember, the company's ROE is a bit low to begin with. So that's what might be causing earnings growth to shrink.

So, as a next step, we compared Falcon Power's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 3.7% in the same period.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Falcon Power's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Falcon Power Efficiently Re-investing Its Profits?

Falcon Power's low three-year median payout ratio of 12% (or a retention ratio of 88%) over the last three years should mean that the company is retaining most of its earnings to fuel its growth but the company's earnings have actually shrunk. This typically shouldn't be the case when a company is retaining most of its earnings. So there might be other factors at play here which could potentially be hampering growth. For instance, the business has faced some headwinds.

In addition, Falcon Power 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.

Summary

On the whole, we feel that the performance shown by Falcon Power can be open to many interpretations. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. 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. To know the 2 risks we have identified for Falcon Power 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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