Is DrayTek Corporation's (TPE:6216) Stock On A Downtrend As A Result Of Its Poor Financials?

DrayTek (TPE:6216) has had a rough month with its share price down 1.9%. To decide if this trend could continue, we decided to look at its weak fundamentals as they shape the long-term market trends. Particularly, we will be paying attention to DrayTek's 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.

Check out our latest analysis for DrayTek

How Is ROE Calculated?

Return on equity 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 DrayTek is:

7.5% = NT$111m ÷ NT$1.5b (Based on the trailing twelve months to September 2020).

The 'return' is the profit over the last twelve months. So, this means that for every NT$1 of its shareholder's investments, the company generates a profit of NT$0.07.

Why Is ROE Important For 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. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

DrayTek's Earnings Growth And 7.5% ROE

At first glance, DrayTek's ROE doesn't look very promising. 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 10.0%. Therefore, it might not be wrong to say that the five year net income decline of 13% seen by DrayTek was probably the result of it having a lower ROE. We reckon that there could also be other factors at play here. For example, it is possible that the business has allocated capital poorly or that the company has a very high payout ratio.

That being said, we compared DrayTek'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 1.5% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. 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 DrayTek is trading on a high P/E or a low P/E, relative to its industry.

Is DrayTek Efficiently Re-investing Its Profits?

DrayTek'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 89% (or a retention ratio of 11%). The business is only left with a small pool of capital to reinvest - A vicious cycle that doesn't benefit the company in the long-run. To know the 4 risks we have identified for DrayTek visit our risks dashboard for free.

In addition, DrayTek has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth.

Summary

On the whole, DrayTek's performance is quite a big let-down. The company has seen a lack of earnings growth as a result of retaining very little profits and whatever little it does retain, is being reinvested at a very low rate of return. Up till now, we've only made a short study of the company's growth data. To gain further insights into DrayTek's past profit growth, check out this visualization of past earnings, revenue and cash flows.

If you decide to trade DrayTek, use the lowest-cost* platform that is rated #1 Overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all from a single integrated account. Promoted

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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.