Will Weakness in Sunonwealth Electric Machine Industry Co., Ltd.'s (TPE:2421) Stock Prove Temporary Given Strong Fundamentals?

It is hard to get excited after looking at Sunonwealth Electric Machine Industry's (TPE:2421) recent performance, when its stock has declined 2.8% over the past month. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Specifically, we decided to study Sunonwealth Electric Machine Industry'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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Sunonwealth Electric Machine Industry

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 Sunonwealth Electric Machine Industry is:

19% = NT$852m ÷ NT$4.6b (Based on the trailing twelve months to December 2020).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each NT$1 of shareholders' capital it has, the company made NT$0.19 in profit.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.

Sunonwealth Electric Machine Industry's Earnings Growth And 19% ROE

To start with, Sunonwealth Electric Machine Industry's ROE looks acceptable. On comparing with the average industry ROE of 9.6% the company's ROE looks pretty remarkable. This certainly adds some context to Sunonwealth Electric Machine Industry's decent 9.8% net income growth seen over the past five years.

As a next step, we compared Sunonwealth Electric Machine Industry's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 2.8%.

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 Sunonwealth Electric Machine Industry's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Sunonwealth Electric Machine Industry Using Its Retained Earnings Effectively?

The high three-year median payout ratio of 83% (or a retention ratio of 17%) for Sunonwealth Electric Machine Industry suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.

Besides, Sunonwealth Electric Machine Industry has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 72%. Still, forecasts suggest that Sunonwealth Electric Machine Industry's future ROE will rise to 26% even though the the company's payout ratio is not expected to change by much.

Conclusion

Overall, we are quite pleased with Sunonwealth Electric Machine Industry's performance. In particular, its high ROE is quite noteworthy and also the probable explanation behind its considerable earnings growth. Yet, the company is retaining a small portion of its profits. Which means that the company has been able to grow its earnings in spite of it, so that's not too bad. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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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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