Can Tex Year Industries Inc.'s (TPE:4720) Weak Financials Pull The Plug On The Stock's Current Momentum On Its Share Price?

Tex Year Industries' (TPE:4720) stock is up by a considerable 11% over the past 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. Particularly, we will be paying attention to Tex Year Industries' 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. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for Tex Year Industries

How Is ROE Calculated?

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 Tex Year Industries is:

6.2% = NT$77m ÷ NT$1.2b (Based on the trailing twelve months to September 2020).

The 'return' is the profit over the last twelve months. That means that for every NT$1 worth of shareholders' equity, the company generated NT$0.06 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 Tex Year Industries' Earnings Growth And 6.2% ROE

On the face of it, Tex Year Industries' ROE is not much to talk about. Yet, a closer study shows that the company's ROE is similar to the industry average of 7.7%. But then again, Tex Year Industries' five year net income shrunk at a rate of 26%. Remember, the company's ROE is a bit low to begin with. Therefore, the decline in earnings could also be the result of this.

So, as a next step, we compared Tex Year Industries' 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. 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. 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 Tex Year Industries is trading on a high P/E or a low P/E, relative to its industry.

Is Tex Year Industries Using Its Retained Earnings Effectively?

With a high three-year median payout ratio of 60% (implying that 40% of the profits are retained), most of Tex Year Industries' 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. To know the 3 risks we have identified for Tex Year Industries visit our risks dashboard for free.

Additionally, Tex Year Industries 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

Overall, we would be extremely cautious before making any decision on Tex Year Industries. Because the company is not reinvesting much into the business, and given the low ROE, it's not surprising to see the lack or absence of growth in its earnings. Up till now, we've only made a short study of the company's growth data. So it may be worth checking this free detailed graph of Tex Year Industries' 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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