It is hard to get excited after looking at SDI's (TPE:2351) recent performance, when its stock has declined 9.4% over the past month. We decided to study the company's financials to determine if the downtrend will continue as the long-term performance of a company usually dictates market outcomes. Particularly, we will be paying attention to SDI'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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.
How Do You Calculate Return On Equity?
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 SDI is:
5.6% = NT$329m ÷ NT$5.8b (Based on the trailing twelve months to September 2020).
The 'return' is the yearly profit. So, this means that for every NT$1 of its shareholder's investments, the company generates a profit of NT$0.06.
What Has ROE Got To Do With 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 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.
SDI's Earnings Growth And 5.6% ROE
At first glance, SDI's ROE doesn't look very promising. Next, when compared to the average industry ROE of 11%, the company's ROE leaves us feeling even less enthusiastic. For this reason, SDI's five year net income decline of 6.6% is not surprising given its lower ROE. We reckon that there could also be other factors at play here. Such as - low earnings retention or poor allocation of capital.
That being said, we compared SDI's 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 9.9% 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. This then helps them determine if the stock is placed for a bright or bleak future. Has the market priced in the future outlook for 2351? You can find out in our latest intrinsic value infographic research report.
Is SDI Using Its Retained Earnings Effectively?
SDI'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 64% (or a retention ratio of 36%). With only a little being reinvested into the business, earnings growth would obviously be low or non-existent. To know the 3 risks we have identified for SDI visit our risks dashboard for free.
Additionally, SDI 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. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 46% over the next three years. As a result, the expected drop in SDI's payout ratio explains the anticipated rise in the company's future ROE to 19%, over the same period.
Overall, we would be extremely cautious before making any decision on SDI. 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. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. 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.
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