Polytronics Technology Corporation's (TPE:6224) Stock Has Seen Strong Momentum: Does That Call For Deeper Study Of Its Financial Prospects?

Polytronics Technology (TPE:6224) has had a great run on the share market with its stock up by a significant 17% over the last three months. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Particularly, we will be paying attention to Polytronics Technology'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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Polytronics Technology

How Do You Calculate Return On Equity?

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 Polytronics Technology is:

18% = NT$384m ÷ NT$2.1b (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$0.18 in profit.

What Is The Relationship Between ROE And 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.

Polytronics Technology's Earnings Growth And 18% ROE

At first glance, Polytronics Technology seems to have a decent ROE. On comparing with the average industry ROE of 9.9% the company's ROE looks pretty remarkable. As you might expect, the 4.9% net income decline reported by Polytronics Technology is a bit of a surprise. Based on this, we feel that there might be other reasons which haven't been discussed so far in this article that could be hampering the company's growth. These include low earnings retention or poor allocation of capital.

However, when we compared Polytronics 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.

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. Has the market priced in the future outlook for 6224? You can find out in our latest intrinsic value infographic research report

Is Polytronics Technology Using Its Retained Earnings Effectively?

Polytronics Technology'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 83% (or a retention ratio of 17%). With only a little being reinvested into the business, earnings growth would obviously be low or non-existent.

Moreover, Polytronics 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.

Conclusion

Overall, we feel that Polytronics Technology certainly does have some positive factors to consider. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE. Bear in mind, the company reinvests a small portion of its profits, which means that investors aren't reaping the benefits of the high rate of return. 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 latest analysts predictions for the company, check out this visualization of analyst forecasts 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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