Kung Long Batteries Industrial Co.,Ltd's (TPE:1537) Fundamentals Look Pretty Strong: Could The Market Be Wrong About The Stock?

With its stock down 2.8% over the past month, it is easy to disregard Kung Long Batteries IndustrialLtd (TPE:1537). However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. In this article, we decided to focus on Kung Long Batteries IndustrialLtd'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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Kung Long Batteries IndustrialLtd

How Do You Calculate Return On Equity?

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 Kung Long Batteries IndustrialLtd is:

23% = NT$887m ÷ NT$3.8b (Based on the trailing twelve months to September 2020).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each NT$1 of shareholders' capital it has, the company made NT$0.23 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 all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

Kung Long Batteries IndustrialLtd's Earnings Growth And 23% ROE

Firstly, we acknowledge that Kung Long Batteries IndustrialLtd has a significantly high ROE. Additionally, the company's ROE is higher compared to the industry average of 7.9% which is quite remarkable. Yet, Kung Long Batteries IndustrialLtd has posted measly growth of 3.7% over the past five years. This is interesting as the high returns should mean that the company has the ability to generate high growth but for some reason, it hasn't been able to do so. A few likely reasons why this could happen is that the company could have a high payout ratio or the business has allocated capital poorly, for instance.

Next, on comparing Kung Long Batteries IndustrialLtd's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth 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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Kung Long Batteries IndustrialLtd's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Kung Long Batteries IndustrialLtd Efficiently Re-investing Its Profits?

Kung Long Batteries IndustrialLtd has a three-year median payout ratio of 83% (implying that it keeps only 17% of its profits), meaning that it pays out most of its profits to shareholders as dividends, and as a result, the company has seen low earnings growth.

In addition, Kung Long Batteries IndustrialLtd has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth.

Conclusion

On the whole, we do feel that Kung Long Batteries IndustrialLtd has some positive attributes. Its earnings have grown respectably as we saw earlier, which was likely due to the company reinvesting its earnings at a pretty high rate of return. However, given the high ROE, we do think that the company is reinvesting a small portion of its profits. This could likely be preventing the company from growing to its full extent. 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. You can see the 1 risk we have identified for Kung Long Batteries IndustrialLtd by visiting our risks dashboard for free on our platform here.

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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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