Formosa Optical Technology Co.,Ltd.'s (GTSM:5312) Stock Has Shown Weakness Lately But Financial Prospects Look Decent: Is The Market Wrong?

With its stock down 1.7% over the past three months, it is easy to disregard Formosa Optical TechnologyLtd (GTSM:5312). However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Specifically, we decided to study Formosa Optical TechnologyLtd's ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for Formosa Optical TechnologyLtd

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 Formosa Optical TechnologyLtd is:

13% = NT$327m ÷ NT$2.5b (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$0.13 in profit.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.

Formosa Optical TechnologyLtd's Earnings Growth And 13% ROE

To begin with, Formosa Optical TechnologyLtd seems to have a respectable ROE. Even when compared to the industry average of 13% the company's ROE looks quite decent. For this reason, Formosa Optical TechnologyLtd's five year net income decline of 3.6% raises the question as to why the decent ROE didn't translate into growth. Based on this, we feel that there might be other reasons which haven't been discussed so far in this article that could be hampering the company's growth. These include low earnings retention or poor allocation of capital.

From the 3.6% decline reported by the industry in the same period, we infer that Formosa Optical TechnologyLtd and its industry are both shrinking at a similar rate.

Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Formosa Optical TechnologyLtd's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Formosa Optical TechnologyLtd Using Its Retained Earnings Effectively?

With a high three-year median payout ratio of 75% (implying that 25% of the profits are retained), most of Formosa Optical TechnologyLtd's 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.

Moreover, Formosa Optical TechnologyLtd has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth.

Conclusion

On the whole, we do feel that Formosa Optical TechnologyLtd has some positive attributes. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE. Bear in mind, the company reinvests a small portion of its profits, which means that investors aren't reaping the benefits of the high rate of return. Up till now, we've only made a short study of the company's growth data. You can do your own research on Formosa Optical TechnologyLtd 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. 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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