Chun Yuan Steel Industry Co., Ltd.'s (TPE:2010) Stock Going Strong But Fundamentals Look Weak: What Implications Could This Have On The Stock?

Chun Yuan Steel Industry (TPE:2010) has had a great run on the share market with its stock up by a significant 35% over the last three months. However, in this article, we decided to focus on its weak fundamentals, as long-term financial performance of a business is what ultimatley dictates market outcomes. Specifically, we decided to study Chun Yuan Steel Industry's ROE in this article.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for Chun Yuan Steel Industry

How To 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 Chun Yuan Steel Industry is:

3.3% = NT$351m ÷ NT$11b (Based on the trailing twelve months to September 2020).

The 'return' is the income the business earned over the last year. That means that for every NT$1 worth of shareholders' equity, the company generated NT$0.03 in profit.

What Is The Relationship Between ROE And 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.

Chun Yuan Steel Industry's Earnings Growth And 3.3% ROE

At first glance, Chun Yuan Steel Industry's ROE doesn't look very promising. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 5.7%. Given the circumstances, the significant decline in net income by 25% seen by Chun Yuan Steel Industry over the last five years is not surprising. 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 Chun Yuan Steel Industry's 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 7.3% in the same period.

Earnings growth is an important metric to consider when valuing a stock. 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. 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 Chun Yuan Steel Industry is trading on a high P/E or a low P/E, relative to its industry.

Is Chun Yuan Steel Industry Using Its Retained Earnings Effectively?

With a high three-year median payout ratio of 94% (implying that 5.6% of the profits are retained), most of Chun Yuan Steel Industry's profits are being paid to shareholders, which explains the company's shrinking earnings. With only a little being reinvested into the business, earnings growth would obviously be low or non-existent. Our risks dashboard should have the 4 risks we have identified for Chun Yuan Steel Industry.

In addition, Chun Yuan Steel Industry has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth.

Summary

On the whole, Chun Yuan Steel Industry's performance is quite a big let-down. Particularly, its ROE is a huge disappointment, not to mention its lack of proper reinvestment into the business. As a result its earnings growth has also been quite disappointing. Until now, we have only just grazed the surface of the company's past performance by looking at the company's fundamentals. So it may be worth checking this free detailed graph of Chun Yuan Steel Industry's past earnings, as well as revenue and cash flows to get a deeper insight into the company's performance.

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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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