Could Tontek Design Technology Ltd.'s (GTSM:5487) Weak Financials Mean That The Market Could Correct Its Share Price?

Most readers would already know that Tontek Design Technology's (GTSM:5487) stock increased by 4.1% over the past month. However, in this article, we decided to focus on its weak financials, as long-term fundamentals ultimately dictate market outcomes. In this article, we decided to focus on Tontek Design Technology's ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. 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 Tontek Design Technology

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 Tontek Design Technology is:

6.0% = NT$33m ÷ NT$552m (Based on the trailing twelve months to September 2020).

The 'return' is the profit 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$0.06 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 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.

Tontek Design Technology's Earnings Growth And 6.0% ROE

At first glance, Tontek Design Technology's ROE doesn't look very promising. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 11% either. Accordingly, Tontek Design Technology's low net income growth of 4.2% over the past five years can possibly be explained by the low ROE amongst other factors.

As a next step, we compared Tontek Design Technology's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 8.9% in the same period.

Earnings growth is an important metric to consider when valuing a stock. 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. Is Tontek Design Technology fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Tontek Design Technology Efficiently Re-investing Its Profits?

The high three-year median payout ratio of 89% (that is, the company retains only 11% of its income) over the past three years for Tontek Design Technology suggests that the company's earnings growth was lower as a result of paying out a majority of its earnings.

In addition, Tontek Design Technology has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth.

Conclusion

Overall, we would be extremely cautious before making any decision on Tontek Design Technology. Because the company is not reinvesting much into the business, and given the low ROE, it's not surprising to see the lack or absence of growth in its earnings. In brief, we think the company is risky and investors should think twice before making any final judgement on this company. Our risks dashboard would have the 4 risks we have identified for Tontek Design Technology.

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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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