Should Weakness in Nishoku Technology Inc.'s (TPE:3679) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?

Nishoku Technology (TPE:3679) has had a rough month with its share price down 5.1%. But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. Specifically, we decided to study Nishoku Technology's ROE in this article.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

View our latest analysis for Nishoku Technology

How To 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 Nishoku Technology is:

15% = NT$621m ÷ NT$4.2b (Based on the trailing twelve months to September 2020).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each NT$1 of shareholders' capital it has, the company made NT$0.15 in profit.

Why Is ROE Important For Earnings Growth?

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

A Side By Side comparison of Nishoku Technology's Earnings Growth And 15% ROE

To begin with, Nishoku Technology seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 9.7%. As you might expect, the 2.2% net income decline reported by Nishoku Technology is a bit of a surprise. Therefore, there might be some other aspects that could explain this. These include low earnings retention or poor allocation of capital.

So, as a next step, we compared Nishoku Technology'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 1.2% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. Is Nishoku Technology fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Nishoku Technology Efficiently Re-investing Its Profits?

Nishoku Technology's declining earnings is not surprising given how the company is spending most of its profits in paying dividends, judging by its three-year median payout ratio of 78% (or a retention ratio of 22%). With only very little left to reinvest into the business, growth in earnings is far from likely. Our risks dashboard should have the 3 risks we have identified for Nishoku Technology.

In addition, Nishoku Technology 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.

Summary

In total, it does look like Nishoku Technology has some positive aspects to its business. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE. Bear in mind, the company reinvests a small portion of its profits, which means that investors aren't reaping the benefits of the high rate of return. Until now, we have only just grazed the surface of the company's past performance by looking at the company's fundamentals. To gain further insights into Nishoku Technology's past profit growth, check out this visualization of past earnings, revenue and cash flows.

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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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