Will Weakness in Alchip Technologies, Limited's (TWSE:3661) Stock Prove Temporary Given Strong Fundamentals?

With its stock down 27% over the past three months, it is easy to disregard Alchip Technologies (TWSE:3661). However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Specifically, we decided to study Alchip Technologies' ROE in this article.

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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for Alchip Technologies

How Is ROE Calculated?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Alchip Technologies is:

14% = NT$4.8b ÷ NT$34b (Based on the trailing twelve months to June 2024).

The 'return' is the yearly profit. One way to conceptualize this is that for each NT$1 of shareholders' capital it has, the company made NT$0.14 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. 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.

Alchip Technologies' Earnings Growth And 14% ROE

To start with, Alchip Technologies' ROE looks acceptable. Especially when compared to the industry average of 10% the company's ROE looks pretty impressive. This probably laid the ground for Alchip Technologies' significant 45% net income growth seen over the past five years. However, there could also be other causes behind this growth. Such as - high earnings retention or an efficient management in place.

Next, on comparing with the industry net income growth, we found that Alchip Technologies' growth is quite high when compared to the industry average growth of 12% in the same period, which is great to see.

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. Is Alchip Technologies fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Alchip Technologies Making Efficient Use Of Its Profits?

The three-year median payout ratio for Alchip Technologies is 47%, which is moderately low. The company is retaining the remaining 53%. 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.

Additionally, Alchip Technologies has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 29% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 24%, over the same period.

Summary

Overall, we are quite pleased with Alchip Technologies' performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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.