Winbond Electronics Corporation's (TPE:2344) Stock's Been Going Strong: Could Weak Financials Mean The Market Will Coorect Its Share Price?

Winbond Electronics (TPE:2344) has had a great run on the share market with its stock up by a significant 50% over the last three months. We, however wanted to have a closer look at its key financial indicators as the markets usually pay for long-term fundamentals, and in this case, they don't look very promising. Particularly, we will be paying attention to Winbond Electronics' 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. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for Winbond Electronics

How Is ROE Calculated?

ROE 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 Winbond Electronics is:

1.6% = NT$987m ÷ NT$63b (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$0.02 in profit.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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 Winbond Electronics' Earnings Growth And 1.6% ROE

It is quite clear that Winbond Electronics' ROE is rather low. Even when compared to the industry average of 11%, the ROE figure is pretty disappointing. For this reason, Winbond Electronics' five year net income decline of 5.0% is not surprising given its lower ROE. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. Such as - low earnings retention or poor allocation of capital.

So, as a next step, we compared Winbond Electronics' 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. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Winbond Electronics''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Winbond Electronics Using Its Retained Earnings Effectively?

With a high three-year median payout ratio of 53% (implying that 47% of the profits are retained), most of Winbond Electronics' profits are being paid to shareholders, which explains the company's shrinking earnings. With only very little left to reinvest into the business, growth in earnings is far from likely. To know the 5 risks we have identified for Winbond Electronics visit our risks dashboard for free.

In addition, Winbond Electronics has been paying dividends over a period of five years suggesting that keeping up dividend payments is preferred by the management even though earnings have been in decline. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 39% over the next three years. The fact that the company's ROE is expected to rise to 6.6% over the same period is explained by the drop in the payout ratio.

Conclusion

On the whole, Winbond Electronics' performance is quite a big let-down. The company has seen a lack of earnings growth as a result of retaining very little profits and whatever little it does retain, is being reinvested at a very low rate of return. In addition, on studying the latest analyst forecasts, we found that the company's earnings are expected to continue to shrink. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

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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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