ELTA Technology Co.,Ltd.'s (GTSM:8487) On An Uptrend But Financial Prospects Look Pretty Weak: Is The Stock Overpriced?

Most readers would already be aware that ELTA TechnologyLtd's (GTSM:8487) stock increased significantly by 13% over the past three months. 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. Particularly, we will be paying attention to ELTA TechnologyLtd's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for ELTA TechnologyLtd

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 ELTA TechnologyLtd is:

2.9% = NT$7.2m ÷ NT$248m (Based on the trailing twelve months to June 2020).

The 'return' refers to a company's earnings 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?

So far, we've learned that ROE is a measure of a company's profitability. 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. 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.

ELTA TechnologyLtd's Earnings Growth And 2.9% ROE

It is hard to argue that ELTA TechnologyLtd's ROE is much good in and of itself. Not just that, even compared to the industry average of 12%, the company's ROE is entirely unremarkable. Therefore, it might not be wrong to say that the five year net income decline of 28% seen by ELTA TechnologyLtd was possibly a result of it having a lower ROE. However, there could also be other factors causing the earnings to decline. For example, the business has allocated capital poorly, or that the company has a very high payout ratio.

However, when we compared ELTA TechnologyLtd's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 20% 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. 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 ELTA TechnologyLtd is trading on a high P/E or a low P/E, relative to its industry.

Is ELTA TechnologyLtd Making Efficient Use Of Its Profits?

ELTA TechnologyLtd has a high three-year median payout ratio of 85% (that is, it is retaining 15% 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. With only very little left to reinvest into the business, growth in earnings is far from likely. You can see the 4 risks we have identified for ELTA TechnologyLtd by visiting our risks dashboard for free on our platform here.

In addition, ELTA TechnologyLtd has been paying dividends over a period of five years suggesting that keeping up dividend payments is preferred by the management even though earnings have been in decline.

Summary

Overall, we would be extremely cautious before making any decision on ELTA TechnologyLtd. 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. So far, we've only made a quick discussion around the company's earnings growth. To gain further insights into ELTA TechnologyLtd'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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