Can Nan Ya Plastics Corporation's (TPE:1303) Weak Financials Pull The Plug On The Stock's Current Momentum On Its Share Price?

Nan Ya Plastics' (TPE:1303) stock is up by a considerable 11% over the past three months. 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 Nan Ya Plastics' ROE.

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. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for Nan Ya Plastics

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 Nan Ya Plastics is:

5.7% = NT$19b ÷ NT$327b (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$0.06.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

Nan Ya Plastics' Earnings Growth And 5.7% ROE

On the face of it, Nan Ya Plastics' ROE is not much to talk about. Next, when compared to the average industry ROE of 7.7%, 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 8.0% seen by Nan Ya Plastics was probably the result of it having a lower ROE. However, there could also be other factors causing the earnings to decline. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

So, as a next step, we compared Nan Ya Plastics' 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 1.0% 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 Nan Ya Plastics fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Nan Ya Plastics Using Its Retained Earnings Effectively?

With a high three-year median payout ratio of 76% (implying that 24% of the profits are retained), most of Nan Ya Plastics' profits are being paid to shareholders, which explains the company's shrinking earnings. 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 2 risks we have identified for Nan Ya Plastics.

Additionally, Nan Ya Plastics 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. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 75%. Regardless, the future ROE for Nan Ya Plastics is predicted to rise to 8.6% despite there being not much change expected in its payout ratio.

Conclusion

In total, we would have a hard think before deciding on any investment action concerning Nan Ya Plastics. The company has seen a lack of earnings growth as a result of retaining very little profits and whatever little it does retain, is being reinvested at a very low rate of return. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

If you’re looking to trade Nan Ya Plastics, open an account with the lowest-cost* platform trusted by professionals, Interactive Brokers. Their clients from over 200 countries and territories trade stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

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