Foxconn Technology Co., Ltd.'s (TPE:2354) Stock Going Strong But Fundamentals Look Weak: What Implications Could This Have On The Stock?

Foxconn Technology's (TPE:2354) stock is up by a considerable 48% over the past three months. However, we decided to pay close attention to its weak financials as we are doubtful that the current momentum will keep up, given the scenario. In this article, we decided to focus on Foxconn Technology's 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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for Foxconn Technology

How Is ROE Calculated?

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 Foxconn Technology is:

5.3% = NT$5.4b ÷ NT$101b (Based on the trailing twelve months to September 2020).

The 'return' is the yearly profit. Another way to think of that is that for every NT$1 worth of equity, the company was able to earn NT$0.05 in profit.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. 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.

Foxconn Technology's Earnings Growth And 5.3% ROE

On the face of it, Foxconn Technology's ROE is not much to talk about. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 9.9%. Therefore, it might not be wrong to say that the five year net income decline of 12% seen by Foxconn Technology was probably the result of it having a lower ROE. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. Such as - low earnings retention or poor allocation of capital.

However, when we compared Foxconn Technology's 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 a huge factor in stock valuation. 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. Is Foxconn Technology fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Foxconn Technology Using Its Retained Earnings Effectively?

With a high three-year median payout ratio of 51% (implying that 49% of the profits are retained), most of Foxconn Technology's profits are being paid to shareholders, which explains the company's shrinking earnings. With only a little being reinvested into the business, earnings growth would obviously be low or non-existent. You can see the 3 risks we have identified for Foxconn Technology by visiting our risks dashboard for free on our platform here.

Moreover, Foxconn Technology 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 49%. However, Foxconn Technology's ROE is predicted to rise to 6.8% despite there being no anticipated change in its payout ratio.

Conclusion

In total, we would have a hard think before deciding on any investment action concerning Foxconn Technology. As a result of its low ROE and lack of mich reinvestment into the business, the company has seen a disappointing earnings growth rate. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. 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. 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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