Can San Fang Chemical Industry Co., Ltd.'s (TPE:1307) Weak Financials Pull The Plug On The Stock's Current Momentum On Its Share Price?

San Fang Chemical Industry (TPE:1307) has had a great run on the share market with its stock up by a significant 7.0% over the last month. 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 San Fang Chemical 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. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for San Fang Chemical Industry

How Is ROE Calculated?

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 San Fang Chemical Industry is:

2.8% = NT$218m ÷ NT$7.9b (Based on the trailing twelve months to December 2020).

The 'return' is the yearly profit. That means that for every NT$1 worth of shareholders' equity, the company generated NT$0.03 in profit.

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. 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.

San Fang Chemical Industry's Earnings Growth And 2.8% ROE

It is quite clear that San Fang Chemical Industry's ROE is rather low. Not just that, even compared to the industry average of 8.0%, the company's ROE is entirely unremarkable. For this reason, San Fang Chemical Industry's five year net income decline of 35% 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. Such as - low earnings retention or poor allocation of capital.

However, when we compared San Fang Chemical Industry's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 1.0% in the same period. This is quite worrisome.

Earnings growth is a huge factor in stock valuation. 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. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if San Fang Chemical Industry is trading on a high P/E or a low P/E, relative to its industry.

Is San Fang Chemical Industry Using Its Retained Earnings Effectively?

San Fang Chemical 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 74% (or a retention ratio of 26%). 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. You can see the 4 risks we have identified for San Fang Chemical Industry by visiting our risks dashboard for free on our platform here.

Moreover, San Fang Chemical Industry 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 would be extremely cautious before making any decision on San Fang Chemical 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 San Fang Chemical 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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