Declining Stock and Decent Financials: Is The Market Wrong About ELAN Microelectronics Corporation (TWSE:2458)?

With its stock down 9.6% over the past month, it is easy to disregard ELAN Microelectronics (TWSE:2458). However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Specifically, we decided to study ELAN Microelectronics' 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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for ELAN Microelectronics

How To 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 ELAN Microelectronics is:

26% = NT$2.4b ÷ NT$9.1b (Based on the trailing twelve months to March 2024).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each NT$1 of shareholders' capital it has, the company made NT$0.26 in profit.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

ELAN Microelectronics' Earnings Growth And 26% ROE

To begin with, ELAN Microelectronics has a pretty high ROE which is interesting. Second, a comparison with the average ROE reported by the industry of 11% also doesn't go unnoticed by us. However, we are curious as to how the high returns still resulted in a flat growth for ELAN Microelectronics in the past five years. We reckon that there could be some other factors at play here that's limiting 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.

We then compared ELAN Microelectronics' net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 14% in the same 5-year period, which is a bit concerning.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if ELAN Microelectronics is trading on a high P/E or a low P/E, relative to its industry.

Is ELAN Microelectronics Using Its Retained Earnings Effectively?

ELAN Microelectronics has a high three-year median payout ratio of 81% (or a retention ratio of 19%), meaning that the company is paying most of its profits as dividends to its shareholders. This does go some way in explaining why there's been no growth in its earnings.

Moreover, ELAN Microelectronics has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 82%. However, ELAN Microelectronics' ROE is predicted to rise to 32% despite there being no anticipated change in its payout ratio.

Conclusion

Overall, we feel that ELAN Microelectronics certainly does have some positive factors to consider. However, while the company does have a high ROE, its earnings growth number is quite disappointing. This can be blamed on the fact that it reinvests only a small portion of its profits and pays out the rest as dividends. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.

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