Does Formosa Taffeta Co., Ltd.'s (TPE:1434) Weak Fundamentals Mean That The Market Could Correct Its Share Price?

Most readers would already be aware that Formosa Taffeta's (TPE:1434) stock increased significantly by 11% over the past three months. However, in this article, we decided to focus on its weak fundamentals, as long-term financial performance of a business is what ultimatley dictates market outcomes. Specifically, we decided to study Formosa Taffeta'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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Formosa Taffeta

How Is ROE Calculated?

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 Formosa Taffeta is:

3.4% = NT$2.1b ÷ NT$61b (Based on the trailing twelve months to December 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$0.03 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. 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. 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.

Formosa Taffeta's Earnings Growth And 3.4% ROE

At first glance, Formosa Taffeta's ROE doesn't look very promising. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 8.1%. As a result, Formosa Taffeta's flat net income growth over the past five years doesn't come as a surprise given its lower ROE.

Next, on comparing with the industry net income growth, we found that Formosa Taffeta's reported growth was a little less than the industry growth of0.6% in the same period.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. Is Formosa Taffeta fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Formosa Taffeta Efficiently Re-investing Its Profits?

Formosa Taffeta has a very high three-year median payout ratio of 106% over the last last three years, which suggests that the company is dipping into more than just its earnings to pay its dividend. This does go some way in explaining the negligible earnings growth seen by Formosa Taffeta. Paying a dividend higher than reported profits is not a sustainable move. This is indicative of risk. Our risks dashboard should have the 3 risks we have identified for Formosa Taffeta.

Additionally, Formosa Taffeta has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth.

Conclusion

In total, we would have a hard think before deciding on any investment action concerning Formosa Taffeta. 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. To gain further insights into Formosa Taffeta'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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