Collins Co., Ltd.'s (TPE:2906) Financial Prospects Don't Look Very Positive: Could It Mean A Stock Price Drop In The Future?

Most readers would already know that Collins' (TPE:2906) stock increased by 9.9% over the past three months. Given that the markets usually pay for the long-term financial health of a company, we wonder if the current momentum in the share price will keep up, given that the company's financials don't look very promising. Particularly, we will be paying attention to Collins' ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Collins

How Is ROE Calculated?

Return on equity can be calculated by using the formula:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Collins is:

3.4% = NT$178m ÷ NT$5.2b (Based on the trailing twelve months to September 2020).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every NT$1 of its shareholder's investments, the company generates a profit of NT$0.03.

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. 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.

Collins' Earnings Growth And 3.4% ROE

When you first look at it, Collins' ROE doesn't look that attractive. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 7.8% either. Therefore, it might not be wrong to say that the five year net income decline of 22% seen by Collins was probably the 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 instance, the company has a very high payout ratio, or is faced with competitive pressures.

That being said, we compared Collins' performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 7.6% in the same period.

Earnings growth is a huge factor in stock valuation. 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. If you're wondering about Collins''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Collins Making Efficient Use Of Its Profits?

Collins' very high three-year median payout ratio of 217% over the last three years suggests that the company is paying its shareholders more than what it is earning and this explains the company's shrinking earnings. Paying a dividend higher than reported profits is not a sustainable move. Our risks dashboard should have the 2 risks we have identified for Collins.

Moreover, Collins 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.

Summary

On the whole, Collins' performance is quite a big let-down. Specifically, it has shown quite an unsatisfactory performance as far as earnings growth is concerned, and a poor ROE and an equally poor rate of reinvestment seem to be the reason behind this inadequate performance. 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 Collins' 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. 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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