Luo Lih-Fen Holding Co., Ltd.'s (TWSE:6666) On An Uptrend But Financial Prospects Look Pretty Weak: Is The Stock Overpriced?

Luo Lih-Fen Holding's (TWSE:6666) stock is up by a considerable 14% over the past week. However, we decided to pay close attention to its weak financials as we are doubtful that the current momentum will keep up, given the scenario. In this article, we decided to focus on Luo Lih-Fen Holding's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Luo Lih-Fen Holding

How Do You 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 Luo Lih-Fen Holding is:

5.6% = NT$97m ÷ NT$1.7b (Based on the trailing twelve months to September 2024).

The 'return' is the yearly profit. So, this means that for every NT$1 of its shareholder's investments, the company generates a profit of NT$0.06.

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. 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.

A Side By Side comparison of Luo Lih-Fen Holding's Earnings Growth And 5.6% ROE

When you first look at it, Luo Lih-Fen Holding's ROE doesn't look that attractive. Next, when compared to the average industry ROE of 9.9%, the company's ROE leaves us feeling even less enthusiastic. Therefore, it might not be wrong to say that the five year net income decline of 43% seen by Luo Lih-Fen Holding was probably the result of it having a lower ROE. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. Such as - low earnings retention or poor allocation of capital.

However, when we compared Luo Lih-Fen Holding's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 7.8% in the same period. This is quite worrisome.

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. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Luo Lih-Fen Holding's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Luo Lih-Fen Holding Using Its Retained Earnings Effectively?

Luo Lih-Fen Holding'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 80% (or a retention ratio of 20%). With only a little being reinvested into the business, earnings growth would obviously be low or non-existent. Our risks dashboard should have the 3 risks we have identified for Luo Lih-Fen Holding.

Additionally, Luo Lih-Fen Holding has paid dividends over a period of six years, which means that the company's management is rather focused on keeping up its dividend payments, regardless of the shrinking earnings.

Summary

In total, we would have a hard think before deciding on any investment action concerning Luo Lih-Fen Holding. 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 Luo Lih-Fen Holding's past profit growth, check out this visualization of past earnings, revenue and cash flows.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.