Could The Market Be Wrong About Alchip Technologies, Limited (TWSE:3661) Given Its Attractive Financial Prospects?

It is hard to get excited after looking at Alchip Technologies' (TWSE:3661) recent performance, when its stock has declined 21% over the past three months. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Particularly, we will be paying attention to Alchip Technologies' ROE today.

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.

View our latest analysis for Alchip Technologies

How To Calculate Return On Equity?

Return on equity 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 Alchip Technologies is:

18% = NT$3.3b ÷ NT$18b (Based on the trailing twelve months to December 2023).

The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every NT$1 worth of equity, the company was able to earn NT$0.18 in profit.

Why Is ROE Important For Earnings Growth?

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

Alchip Technologies' Earnings Growth And 18% ROE

To start with, Alchip Technologies' ROE looks acceptable. On comparing with the average industry ROE of 9.6% the company's ROE looks pretty remarkable. Probably as a result of this, Alchip Technologies was able to see an impressive net income growth of 43% over the last five years. We reckon that there could also be other factors at play here. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

We then compared Alchip Technologies' net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 17% in the same 5-year 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. This then helps them determine if the stock is placed for a bright or bleak future. Is Alchip Technologies fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Alchip Technologies Using Its Retained Earnings Effectively?

Alchip Technologies' three-year median payout ratio is a pretty moderate 48%, meaning the company retains 52% of its income. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like Alchip Technologies is reinvesting its earnings efficiently.

Moreover, Alchip Technologies is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 50% of its profits over the next three years. However, Alchip Technologies' ROE is predicted to rise to 35% despite there being no anticipated change in its payout ratio.

Conclusion

In total, we are pretty happy with Alchip Technologies' performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. On studying current analyst estimates, we found that analysts expect the company to continue its recent growth streak. 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. 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.