Should Weakness in Pan German Universal Motors Ltd.'s (TPE:2247) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?

Pan German Universal Motors (TPE:2247) has had a rough three months with its share price down 25%. However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Particularly, we will be paying attention to Pan German Universal Motors' ROE today.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

View our latest analysis for Pan German Universal Motors

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 Pan German Universal Motors is:

11% = NT$1.0b ÷ NT$8.9b (Based on the trailing twelve months to September 2020).

The 'return' is the yearly profit. Another way to think of that is that for every NT$1 worth of equity, the company was able to earn NT$0.11 in profit.

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 everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

Pan German Universal Motors' Earnings Growth And 11% ROE

At first glance, Pan German Universal Motors seems to have a decent ROE. Even when compared to the industry average of 13% the company's ROE looks quite decent. For this reason, Pan German Universal Motors' five year net income decline of 9.2% raises the question as to why the decent ROE didn't translate into growth. So, there might be some other aspects that could explain this. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.

Next, when we compared with the industry, which has shrunk its earnings at a rate of 3.6% in the same period, we still found Pan German Universal Motors' performance to be quite bleak, because the company has been shrinking its earnings faster than the industry.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. 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 Pan German Universal Motors is trading on a high P/E or a low P/E, relative to its industry.

Is Pan German Universal Motors Efficiently Re-investing Its Profits?

Pan German Universal Motors has a high three-year median payout ratio of 71% (that is, it is retaining 29% 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. You can see the 4 risks we have identified for Pan German Universal Motors by visiting our risks dashboard for free on our platform here.

Additionally, Pan German Universal Motors has paid dividends over a period of three years, which means that the company's management is rather focused on keeping up its dividend payments, regardless of the shrinking earnings.

Conclusion

In total, it does look like Pan German Universal Motors has some positive aspects to its business. 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. Until now, we have only just grazed the surface of the company's past performance by looking at the company's fundamentals. You can do your own research on Pan German Universal Motors 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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