Taiwan Semiconductor Co., Ltd.'s (GTSM:5425) Stock On An Uptrend: Could Fundamentals Be Driving The Momentum?

Most readers would already be aware that Taiwan Semiconductor's (GTSM:5425) stock increased significantly by 43% over the past three months. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Particularly, we will be paying attention to Taiwan Semiconductor's ROE today.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

Check out our latest analysis for Taiwan Semiconductor

How Is ROE Calculated?

The formula for ROE is:

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

So, based on the above formula, the ROE for Taiwan Semiconductor is:

12% = NT$906m ÷ NT$7.3b (Based on the trailing twelve months to September 2020).

The 'return' is the yearly profit. That means that for every NT$1 worth of shareholders' equity, the company generated NT$0.12 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. 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 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.

A Side By Side comparison of Taiwan Semiconductor's Earnings Growth And 12% ROE

To start with, Taiwan Semiconductor's ROE looks acceptable. Even when compared to the industry average of 11% the company's ROE looks quite decent. As you might expect, the 7.5% net income decline reported by Taiwan Semiconductor is a bit of a surprise. 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. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.

So, as a next step, we compared Taiwan Semiconductor's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 8.9% in the same period.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. Is Taiwan Semiconductor fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Taiwan Semiconductor Using Its Retained Earnings Effectively?

Taiwan Semiconductor's declining earnings is not surprising given how the company is spending most of its profits in paying dividends, judging by its three-year median payout ratio of 75% (or a retention ratio of 25%). With only a little being reinvested into the business, earnings growth would obviously be low or non-existent. You can see the 3 risks we have identified for Taiwan Semiconductor by visiting our risks dashboard for free on our platform here.

Additionally, Taiwan Semiconductor has paid dividends over a period of eight years, which means that the company's management is rather focused on keeping up its dividend payments, regardless of the shrinking earnings.

Conclusion

On the whole, we do feel that Taiwan Semiconductor 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. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

If you decide to trade Taiwan Semiconductor, use the lowest-cost* platform that is rated #1 Overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all from a single integrated account. Promoted

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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com.