ABC Taiwan Electronics Corp.'s (GTSM:3236) Stock Is Rallying But Financials Look Ambiguous: Will The Momentum Continue?

Most readers would already be aware that ABC Taiwan Electronics' (GTSM:3236) stock increased significantly by 36% over the past three months. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. In this article, we decided to focus on ABC Taiwan Electronics' ROE.

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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for ABC Taiwan Electronics

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 ABC Taiwan Electronics is:

4.3% = NT$55m ÷ NT$1.3b (Based on the trailing twelve months to September 2020).

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$0.04 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. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.

A Side By Side comparison of ABC Taiwan Electronics' Earnings Growth And 4.3% ROE

When you first look at it, ABC Taiwan Electronics' ROE doesn't look that attractive. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 9.9% either. For this reason, ABC Taiwan Electronics' five year net income decline of 8.7% is not surprising given its lower ROE. However, there could also be other factors causing the earnings to decline. For example, it is possible that the business has allocated capital poorly or that the company has a very high payout ratio.

However, when we compared ABC Taiwan Electronics' growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 9.2% in the same period. This is quite worrisome.

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 ABC Taiwan Electronics''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is ABC Taiwan Electronics Making Efficient Use Of Its Profits?

ABC Taiwan Electronics' low three-year median payout ratio of 22% (implying that it retains the remaining 78% of its profits) comes as a surprise when you pair it with the shrinking earnings. The low payout should mean that the company is retaining most of its earnings and consequently, should see some growth. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Moreover, ABC Taiwan Electronics 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.

Conclusion

On the whole, we feel that the performance shown by ABC Taiwan Electronics can be open to many interpretations. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. You can see the 5 risks we have identified for ABC Taiwan Electronics by visiting our risks dashboard for free on our platform here.

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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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