Are Formosa Oilseed Processing Co., Ltd.'s (TPE:1225) Mixed Financials The Reason For Its Gloomy Performance on The Stock Market?

It is hard to get excited after looking at Formosa Oilseed Processing's (TPE:1225) recent performance, when its stock has declined 9.3% over the past month. It is possible that the markets have ignored the company's differing financials and decided to lean-in to the negative sentiment. Long-term fundamentals are usually what drive market outcomes, so it's worth paying close attention. Particularly, we will be paying attention to Formosa Oilseed Processing'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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

See our latest analysis for Formosa Oilseed Processing

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 Formosa Oilseed Processing is:

10% = NT$370m ÷ NT$3.6b (Based on the trailing twelve months to September 2020).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every NT$1 of its shareholder's investments, the company generates a profit of NT$0.10.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 Oilseed Processing's Earnings Growth And 10% ROE

To begin with, Formosa Oilseed Processing seems to have a respectable ROE. Further, the company's ROE is similar to the industry average of 11%. As you might expect, the 14% net income decline reported by Formosa Oilseed Processing is a bit of a surprise. We reckon that there could be some other factors at play here that are preventing the company's growth. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.

So, as a next step, we compared Formosa Oilseed Processing'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 7.3% in the same period.

Earnings growth is a huge factor in stock valuation. 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. If you're wondering about Formosa Oilseed Processing's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Formosa Oilseed Processing Making Efficient Use Of Its Profits?

Formosa Oilseed Processing'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 98% (or a retention ratio of 1.6%). 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. Our risks dashboard should have the 3 risks we have identified for Formosa Oilseed Processing.

Moreover, Formosa Oilseed Processing has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth.

Summary

Overall, we have mixed feelings about Formosa Oilseed Processing. Despite the high ROE, the company has a disappointing earnings growth number, due to its poor rate of reinvestment into its business. So far, we've only made a quick discussion around the company's earnings growth. You can do your own research on Formosa Oilseed Processing and see how it has performed in the past by looking at this FREE detailed graph 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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