Do Its Financials Have Any Role To Play In Driving LARGAN Precision Co.,Ltd's (TWSE:3008) Stock Up Recently?

Most readers would already be aware that LARGAN PrecisionLtd's (TWSE:3008) stock increased significantly by 40% over the past 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. In this article, we decided to focus on LARGAN PrecisionLtd's ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for LARGAN PrecisionLtd

How To 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 LARGAN PrecisionLtd is:

12% = NT$21b ÷ NT$168b (Based on the trailing twelve months to March 2024).

The 'return' is the yearly profit. One way to conceptualize this is that for each NT$1 of shareholders' capital it has, the company made NT$0.12 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. 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. 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.

LARGAN PrecisionLtd's Earnings Growth And 12% ROE

At first glance, LARGAN PrecisionLtd seems to have a decent ROE. Further, the company's ROE compares quite favorably to the industry average of 8.5%. Needless to say, we are quite surprised to see that LARGAN PrecisionLtd's net income shrunk at a rate of 8.7% over the past five years. Therefore, there might be some other aspects that could explain this. These include low earnings retention or poor allocation of capital.

That being said, we compared LARGAN PrecisionLtd'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 12% in the same 5-year 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. This then helps them determine if the stock is placed for a bright or bleak future. 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 LARGAN PrecisionLtd is trading on a high P/E or a low P/E, relative to its industry.

Is LARGAN PrecisionLtd Using Its Retained Earnings Effectively?

LARGAN PrecisionLtd has a high three-year median payout ratio of 50% (that is, it is retaining 50% of its profits). This suggests that the company is paying most of its profits as dividends to its shareholders. This goes some way in explaining why its earnings have been shrinking. With only a little being reinvested into the business, earnings growth would obviously be low or non-existent.

In addition, LARGAN PrecisionLtd 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. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 53%. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 13%.

Summary

In total, it does look like LARGAN PrecisionLtd has some positive aspects to its business. 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. 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. 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.

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

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.

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