Asia Optical Co., Inc.'s (TWSE:3019) On An Uptrend But Financial Prospects Look Pretty Weak: Is The Stock Overpriced?

Asia Optical's (TWSE:3019) stock is up by a considerable 15% 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 Asia Optical's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Asia Optical

How To Calculate Return On Equity?

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 Asia Optical is:

8.4% = NT$1.3b ÷ NT$16b (Based on the trailing twelve months to June 2024).

The 'return' is the income the business earned over the last year. Another way to think of that is that for every NT$1 worth of equity, the company was able to earn NT$0.08 in profit.

What Has ROE Got To Do With 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.

Asia Optical's Earnings Growth And 8.4% ROE

On the face of it, Asia Optical's ROE is not much to talk about. However, given that the company's ROE is similar to the average industry ROE of 8.5%, we may spare it some thought. Still, Asia Optical has seen a flat net income growth over the past five years. Bear in mind, the company's ROE is not very high. So that could also be one of the reasons behind the company's flat growth in earnings.

As a next step, we compared Asia Optical's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 12% in the same period.

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). 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 Asia Optical is trading on a high P/E or a low P/E, relative to its industry.

Is Asia Optical Making Efficient Use Of Its Profits?

The high three-year median payout ratio of 61% (meaning, the company retains only 39% of profits) for Asia Optical suggests that the company's earnings growth was miniscule as a result of paying out a majority of its earnings.

In addition, Asia Optical has been paying dividends over a period of eight 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, Asia Optical's performance is quite a big let-down. As a result of its low ROE and lack of much reinvestment into the business, the company has seen a disappointing earnings growth rate. Until now, we have only just grazed the surface of the company's past performance by looking at the company's fundamentals. So it may be worth checking this free detailed graph of Asia Optical's past earnings, as well as revenue and cash flows to get a deeper insight into the company's performance.

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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.