Eternal Materials Co., Ltd.'s (TWSE:1717) Has Been On A Rise But Financial Prospects Look Weak: Is The Stock Overpriced?

Eternal Materials (TWSE:1717) has had a great run on the share market with its stock up by a significant 10% over the last month. We, however wanted to have a closer look at its key financial indicators as the markets usually pay for long-term fundamentals, and in this case, they don't look very promising. Specifically, we decided to study Eternal Materials' 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 Eternal Materials

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 Eternal Materials is:

7.1% = NT$1.9b ÷ NT$27b (Based on the trailing twelve months to June 2024).

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$0.07 in profit.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.

Eternal Materials' Earnings Growth And 7.1% ROE

When you first look at it, Eternal Materials' ROE doesn't look that attractive. However, its ROE is similar to the industry average of 7.8%, so we won't completely dismiss the company. But then again, Eternal Materials' five year net income shrunk at a rate of 4.5%. Remember, the company's ROE is a bit low to begin with. So that's what might be causing earnings growth to shrink.

However, when we compared Eternal Materials' growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 7.8% in the same period. This is quite worrisome.

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. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Eternal Materials''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Eternal Materials Making Efficient Use Of Its Profits?

Eternal Materials has a high three-year median payout ratio of 54% (that is, it is retaining 46% of its profits). This suggests that the company is paying most of its profits as dividends to its shareholders. This goes some way in explaining why its earnings have been shrinking. 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. To know the 3 risks we have identified for Eternal Materials visit our risks dashboard for free.

Additionally, Eternal Materials 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.

Summary

Overall, we would be extremely cautious before making any decision on Eternal Materials. As a result of its low ROE and lack of much reinvestment into the business, the company has seen a disappointing earnings growth rate. 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 Eternal Materials' 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. 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.