Eternal Materials Co., Ltd.'s (TPE:1717) Stock Has Seen Strong Momentum: Does That Call For Deeper Study Of Its Financial Prospects?

Most readers would already be aware that Eternal Materials' (TPE:1717) stock increased significantly by 5.3% over the past month. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. In this article, we decided to focus on Eternal Materials' ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for Eternal Materials

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 Eternal Materials is:

10% = NT$2.3b ÷ NT$22b (Based on the trailing twelve months to September 2020).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each NT$1 of shareholders' capital it has, the company made NT$0.10 in profit.

What Has ROE Got To Do With 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. 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.

Eternal Materials' Earnings Growth And 10% ROE

To begin with, Eternal Materials seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 8.0%. As you might expect, the 7.9% net income decline reported by Eternal Materials is a bit of a surprise. Based on this, we feel that there might be other reasons which haven't been discussed so far in this article that could be hampering the company's growth. These include low earnings retention or poor allocation of capital.

However, when we compared Eternal Materials' 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.

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). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Eternal Materials fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Eternal Materials Efficiently Re-investing Its Profits?

Eternal Materials has a high three-year median payout ratio of 57% (that is, it is retaining 43% of its profits). This suggests that the company is paying most of its profits as dividends to its shareholders. This goes some way in explaining why its earnings have been shrinking. 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 3 risks we have identified for Eternal Materials visit our risks dashboard for free.

Additionally, Eternal Materials 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.

Conclusion

On the whole, we do feel that Eternal Materials has some positive attributes. However, while the company does have a high ROE, its earnings growth number is quite disappointing. This can be blamed on the fact that it reinvests only a small portion of its profits and pays out the rest as dividends. Up till now, we've only made a short study of the company's growth data. To gain further insights into Eternal Materials' 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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