Most readers would already know that E-Life's (TPE:6281) stock increased by 6.1% over the past three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to investigate if the company's decent financials had a hand to play in the recent price move. Specifically, we decided to study E-Life'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. Put another way, it reveals the company's success at turning shareholder investments into profits.
How To Calculate Return On Equity?
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 E-Life is:
22% = NT$559m ÷ NT$2.5b (Based on the trailing twelve months to September 2020).
The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each NT$1 of shareholders' capital it has, the company made NT$0.22 in profit.
What Is The Relationship Between ROE And Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.
E-Life's Earnings Growth And 22% ROE
Firstly, we acknowledge that E-Life has a significantly high ROE. Additionally, the company's ROE is higher compared to the industry average of 13% which is quite remarkable. Given the circumstances, we can't help but wonder why E-Life saw little to no growth in the past five years. We reckon that there could be some other factors at play here that's limiting the company's growth. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.
As a next step, we compared E-Life's performance with the industry and discovered the industry has shrunk at a rate of 3.6% in the same period meaning that the company has been shrinking its earnings at a rate lower than the industry. This does appease the negative sentiment around the company to a certain extent.
Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is E-Life fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is E-Life Using Its Retained Earnings Effectively?
The high three-year median payout ratio of 88% (meaning, the company retains only 12% of profits) for E-Life suggests that the company's earnings growth was miniscule as a result of paying out a majority of its earnings.
Additionally, E-Life 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.
On the whole, we do feel that E-Life 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. Until now, we have only just grazed the surface of the company's past performance by looking at the company's fundamentals. To gain further insights into E-Life'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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