Is Cheng Loong Corporation's(TPE:1904) Recent Stock Performance Tethered To Its Strong Fundamentals?

Cheng Loong (TPE:1904) has had a great run on the share market with its stock up by a significant 8.7% over the last month. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. Particularly, we will be paying attention to Cheng Loong's ROE today.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Cheng Loong

How Is ROE Calculated?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Cheng Loong is:

13% = NT$3.4b ÷ NT$26b (Based on the trailing twelve months to September 2020).

The 'return' refers to a company's earnings over the last year. That means that for every NT$1 worth of shareholders' equity, the company generated NT$0.13 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. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.

Cheng Loong's Earnings Growth And 13% ROE

To begin with, Cheng Loong seems to have a respectable ROE. Especially when compared to the industry average of 7.1% the company's ROE looks pretty impressive. This probably laid the ground for Cheng Loong's significant 23% net income growth seen over the past five years. We reckon that there could also be other factors at play here. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

When you consider the fact that the industry earnings have shrunk at a rate of 3.2% in the same period, the company's net income growth is pretty remarkable.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Cheng Loong fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Cheng Loong Using Its Retained Earnings Effectively?

The three-year median payout ratio for Cheng Loong is 48%, which is moderately low. The company is retaining the remaining 52%. So it seems that Cheng Loong is reinvesting efficiently in a way that it sees impressive growth in its earnings (discussed above) and pays a dividend that's well covered.

Moreover, Cheng Loong is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years.

Conclusion

On the whole, we feel that Cheng Loong's performance has been quite good. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

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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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