Leechi Machinery Industry Ltd. Co.'s (TPE:1517) Stock's Been Going Strong: Could Weak Financials Mean The Market Will Coorect Its Share Price?

Most readers would already be aware that Leechi Machinery Industry's (TPE:1517) stock increased significantly by 24% over the past three months. We, however wanted to have a closer look at its key financial indicators as the markets usually pay for long-term fundamentals, and in this case, they don't look very promising. Particularly, we will be paying attention to Leechi Machinery Industry's ROE today.

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.

Check out our latest analysis for Leechi Machinery Industry

How To Calculate Return On Equity?

ROE 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 Leechi Machinery Industry is:

0.9% = NT$29m ÷ NT$3.2b (Based on the trailing twelve months to September 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$0.01.

What Has ROE Got To Do With 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. 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.

Leechi Machinery Industry's Earnings Growth And 0.9% ROE

It is quite clear that Leechi Machinery Industry's ROE is rather low. Even when compared to the industry average of 15%, the ROE figure is pretty disappointing. For this reason, Leechi Machinery Industry's five year net income decline of 46% is not surprising given its lower ROE. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

That being said, we compared Leechi Machinery Industry'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 5.0% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. 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 Leechi Machinery Industry's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Leechi Machinery Industry Making Efficient Use Of Its Profits?

Leechi Machinery Industry'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 53% (or a retention ratio of 47%). The business is only left with a small pool of capital to reinvest - A vicious cycle that doesn't benefit the company in the long-run. To know the 2 risks we have identified for Leechi Machinery Industry visit our risks dashboard for free.

Additionally, Leechi Machinery Industry 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.

Summary

In total, we would have a hard think before deciding on any investment action concerning Leechi Machinery Industry. Because the company is not reinvesting much into the business, and given the low ROE, it's not surprising to see the lack or absence of growth in its earnings. So far, we've only made a quick discussion around the company's earnings growth. To gain further insights into Leechi Machinery Industry'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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