Pegatron Corporation's (TPE:4938) Stock On An Uptrend: Could Fundamentals Be Driving The Momentum?

Pegatron's (TPE:4938) stock is up by a considerable 22% over the past three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. In this article, we decided to focus on Pegatron'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. Put another way, it reveals the company's success at turning shareholder investments into profits.

View our latest analysis for Pegatron

How Is ROE Calculated?

ROE 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 Pegatron is:

13% = NT$25b ÷ NT$195b (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$0.13 in profit.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 Pegatron's Earnings Growth And 13% ROE

At first glance, Pegatron seems to have a decent ROE. Further, the company's ROE is similar to the industry average of 11%. However, while Pegatron has a pretty respectable ROE, its five year net income decline rate was 5.1% . We reckon that there could be some other factors at play here that are preventing the company's growth. These include low earnings retention or poor allocation of capital.

However, when we compared Pegatron's 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.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. Is 4938 fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Pegatron Using Its Retained Earnings Effectively?

With a high three-year median payout ratio of 77% (implying that 23% of the profits are retained), most of Pegatron's profits are being paid to shareholders, which explains the company's shrinking earnings. With only very little left to reinvest into the business, growth in earnings is far from likely. Our risks dashboard should have the 4 risks we have identified for Pegatron.

Moreover, Pegatron 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. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 69% of its profits over the next three years. Accordingly, forecasts suggest that Pegatron's future ROE will be 10% which is again, similar to the current ROE.

Conclusion

On the whole, we do feel that Pegatron has some positive attributes. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return. Investors could have benefitted from the high ROE, had the company been reinvesting more of its earnings. As discussed earlier, the company is retaining a small portion of its profits. Moreover, after studying current analyst estimates, we discovered that the company's earnings are expected to continue to shrink 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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