Compal Electronics, Inc.'s (TPE:2324) On An Uptrend But Financial Prospects Look Pretty Weak: Is The Stock Overpriced?

Compal Electronics' (TPE:2324) stock is up by a considerable 20% over the past three months. However, in this article, we decided to focus on its weak fundamentals, as long-term financial performance of a business is what ultimatley dictates market outcomes. Particularly, we will be paying attention to Compal Electronics' ROE today.

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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for Compal Electronics

How Do You Calculate Return On Equity?

The formula for ROE is:

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

So, based on the above formula, the ROE for Compal Electronics is:

6.9% = NT$7.7b ÷ NT$112b (Based on the trailing twelve months to September 2020).

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$0.07 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 Compal Electronics' Earnings Growth And 6.9% ROE

At first glance, Compal Electronics' 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, Compal Electronics' five year net income decline of 4.8% is not surprising given its lower ROE. We reckon that there could also be other factors at play here. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

However, when we compared Compal Electronics' growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 6.1% in the same period. This is quite worrisome.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). 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 Compal Electronics is trading on a high P/E or a low P/E, relative to its industry.

Is Compal Electronics Making Efficient Use Of Its Profits?

Compal Electronics' 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 77% (or a retention ratio of 23%). With only very little left to reinvest into the business, growth in earnings is far from likely. You can see the 2 risks we have identified for Compal Electronics by visiting our risks dashboard for free on our platform here.

Moreover, Compal 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. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 65%. Still, forecasts suggest that Compal Electronics' future ROE will rise to 8.4% even though the the company's payout ratio is not expected to change by much.

Summary

Overall, we would be extremely cautious before making any decision on Compal Electronics. Because the company is not reinvesting much into the business, and given the low ROE, it's not surprising to see the lack or absence of growth in its earnings. 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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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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