Does Headway Advanced Materials Inc.'s (TPE:1776) Weak Fundamentals Mean A Downturn In Its Stock Should Be Expected?

Headway Advanced Materials' (TPE:1776) stock up by 1.9% over the past three months. However, in this article, we decided to focus on its weak financials, as long-term fundamentals ultimately dictate market outcomes. In this article, we decided to focus on Headway Advanced Materials' ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. 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 Headway Advanced Materials

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 Headway Advanced Materials is:

5.0% = NT$53m ÷ NT$1.1b (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$0.05.

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.

Headway Advanced Materials' Earnings Growth And 5.0% ROE

At first glance, Headway Advanced Materials' ROE doesn't look very promising. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 8.0% either. Therefore, it might not be wrong to say that the five year net income decline of 33% seen by Headway Advanced Materials 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. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

So, as a next step, we compared Headway Advanced Materials' 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.

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 Headway Advanced Materials is trading on a high P/E or a low P/E, relative to its industry.

Is Headway Advanced Materials Efficiently Re-investing Its Profits?

While the company did payout a portion of its dividend in the past, it currently doesn't pay a dividend. This implies that potentially all of its profits are being reinvested in the business.

Summary

In total, we would have a hard think before deciding on any investment action concerning Headway Advanced Materials. The low ROE, combined with the fact that the company is paying out almost if not all, of its profits as dividends, has resulted in the lack or absence of growth in its earnings. Until now, we have only just grazed the surface of the company's past performance by looking at the company's fundamentals. To gain further insights into Headway Advanced 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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