Everlight Chemical Industrial Corporation's (TWSE:1711) On An Uptrend But Financial Prospects Look Pretty Weak: Is The Stock Overpriced?

Most readers would already be aware that Everlight Chemical Industrial's (TWSE:1711) stock increased significantly by 14% over the past month. However, in this article, we decided to focus on its weak fundamentals, as long-term financial performance of a business is what ultimately dictates market outcomes. In this article, we decided to focus on Everlight Chemical Industrial's ROE.

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.

View our latest analysis for Everlight Chemical Industrial

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 Everlight Chemical Industrial is:

1.7% = NT$152m ÷ NT$8.7b (Based on the trailing twelve months to September 2023).

The 'return' refers to a company's earnings over the last year. So, this means that for every NT$1 of its shareholder's investments, the company generates a profit of NT$0.02.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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 Everlight Chemical Industrial's Earnings Growth And 1.7% ROE

It is quite clear that Everlight Chemical Industrial's ROE is rather low. Even compared to the average industry ROE of 7.0%, the company's ROE is quite dismal. Therefore, it might not be wrong to say that the five year net income decline of 5.7% seen by Everlight Chemical Industrial was possibly a 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 example, the business has allocated capital poorly, or that the company has a very high payout ratio.

So, as a next step, we compared Everlight Chemical Industrial'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 9.1% over the last few years.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. 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 Everlight Chemical Industrial is trading on a high P/E or a low P/E, relative to its industry.

Is Everlight Chemical Industrial Making Efficient Use Of Its Profits?

Everlight Chemical Industrial's declining earnings is not surprising given how the company is spending most of its profits in paying dividends, judging by its three-year median payout ratio of 65% (or a retention ratio of 35%). The business is only left with a small pool of capital to reinvest - A vicious cycle that doesn't benefit the company in the long-run. You can see the 2 risks we have identified for Everlight Chemical Industrial by visiting our risks dashboard for free on our platform here.

In addition, Everlight Chemical Industrial 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

Overall, we would be extremely cautious before making any decision on Everlight Chemical Industrial. As a result of its low ROE and lack of much reinvestment into the business, the company has seen a disappointing earnings growth rate. Up till now, we've only made a short study of the company's growth data. You can do your own research on Everlight Chemical Industrial and see how it has performed in the past by looking at this FREE detailed graph of past earnings, revenue and cash flows.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.