Chih Lien Industrial Co., Ltd.'s (TPE:2024) Has Been On A Rise But Financial Prospects Look Weak: Is The Stock Overpriced?

Chih Lien Industrial (TPE:2024) has had a great run on the share market with its stock up by a significant 18% over the last month. However, we decided to pay close attention to its weak financials as we are doubtful that the current momentum will keep up, given the scenario. Specifically, we decided to study Chih Lien Industrial'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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

View our latest analysis for Chih Lien Industrial

How Do You Calculate Return On Equity?

The formula for ROE is:

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

So, based on the above formula, the ROE for Chih Lien Industrial is:

2.4% = NT$27m ÷ NT$1.1b (Based on the trailing twelve months to December 2020).

The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every NT$1 worth of equity, the company was able to earn NT$0.02 in profit.

Why Is ROE Important For 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. 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.

A Side By Side comparison of Chih Lien Industrial's Earnings Growth And 2.4% ROE

As you can see, Chih Lien Industrial's ROE looks pretty weak. Not just that, even compared to the industry average of 4.5%, the company's ROE is entirely unremarkable. Therefore, it might not be wrong to say that the five year net income decline of 22% seen by Chih Lien Industrial was possibly a result of it having a lower ROE. 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.

That being said, we compared Chih Lien Industrial's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 5.4% in the same period.

Earnings growth is an important metric to consider when valuing a stock. 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 Chih Lien Industrial is trading on a high P/E or a low P/E, relative to its industry.

Is Chih Lien Industrial Making Efficient Use Of 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.

Conclusion

In total, we would have a hard think before deciding on any investment action concerning Chih Lien Industrial. The company has seen a lack of earnings growth as a result of retaining very little profits and whatever little it does retain, is being reinvested at a very low rate of return. Up till now, we've only made a short study of the company's growth data. To gain further insights into Chih Lien Industrial'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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