Could China Ecotek Corporation's (TPE:1535) Weak Financials Mean That The Market Could Correct Its Share Price?

China Ecotek's (TPE:1535) stock is up by 5.0% over the past month. However, its weak financial performance indicators makes us a bit doubtful if that trend could continue. Particularly, we will be paying attention to China Ecotek's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for China Ecotek

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 China Ecotek is:

5.2% = NT$149m ÷ NT$2.9b (Based on the trailing twelve months to June 2020).

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

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.

China Ecotek's Earnings Growth And 5.2% ROE

On the face of it, China Ecotek's ROE is not much to talk about. Next, when compared to the average industry ROE of 8.1%, the company's ROE leaves us feeling even less enthusiastic. Therefore, it might not be wrong to say that the five year net income decline of 38% seen by China Ecotek was probably the result of it having a lower ROE. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. Such as - low earnings retention or poor allocation of capital.

That being said, we compared China Ecotek's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 13% in the same period.

Earnings growth is a huge factor in stock valuation. 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. If you're wondering about China Ecotek's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is China Ecotek Using Its Retained Earnings Effectively?

China Ecotek's very high three-year median payout ratio of 117% over the last three years suggests that the company is paying its shareholders more than what it is earning and this explains the company's shrinking earnings. Its usually very hard to sustain dividend payments that are higher than reported profits. You can see the 2 risks we have identified for China Ecotek by visiting our risks dashboard for free on our platform here.

Moreover, China Ecotek 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.

Conclusion

In total, we would have a hard think before deciding on any investment action concerning China Ecotek. The low ROE, combined with the fact that the company is paying out almost if not all, of its profits as dividends, has resulted in the lack or absence of growth in its earnings. Up till now, we've only made a short study of the company's growth data. So it may be worth checking this free detailed graph of China Ecotek's past earnings, as well as revenue and cash flows to get a deeper insight into the company's performance.

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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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