Does Chant Sincere Co., Ltd.'s (TPE:6205) Weak Fundamentals Mean That The Market Could Correct Its Share Price?

Most readers would already be aware that Chant Sincere's (TPE:6205) stock increased significantly by 16% 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 Chant Sincere'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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

See our latest analysis for Chant Sincere

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 Chant Sincere is:

7.2% = NT$127m ÷ NT$1.8b (Based on the trailing twelve months to September 2020).

The 'return' refers to a company's earnings over the last year. That means that for every NT$1 worth of shareholders' equity, the company generated NT$0.07 in profit.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

A Side By Side comparison of Chant Sincere's Earnings Growth And 7.2% ROE

On the face of it, Chant Sincere's ROE is not much to talk about. 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, Chant Sincere's five year net income decline of 16% is not surprising given its 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.

That being said, we compared Chant Sincere's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 9.2% in the same period.

Earnings growth is an important metric to consider when valuing a stock. 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. If you're wondering about Chant Sincere's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Chant Sincere Using Its Retained Earnings Effectively?

Chant Sincere's 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 68% (or a retention ratio of 32%). With only very little left to reinvest into the business, growth in earnings is far from likely. To know the 2 risks we have identified for Chant Sincere visit our risks dashboard for free.

Moreover, Chant Sincere 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.

Summary

Overall, we would be extremely cautious before making any decision on Chant Sincere. As a result of its low ROE and lack of mich reinvestment into the business, the company has seen a disappointing earnings growth rate. 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. 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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