Deswell Industries, Inc.'s (NASDAQ:DSWL) Stock Has Seen Strong Momentum: Does That Call For Deeper Study Of Its Financial Prospects?

Simply Wall St

Sat, Jun 12, 2021, 2:11 AM 4 min read

Deswell Industries (NASDAQ:DSWL) has had a great run on the share market with its stock up by a significant 26% over the last three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. In this article, we decided to focus on Deswell Industries' 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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for Deswell Industries

How Do You 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 Deswell Industries is:

9.6% = US$8.2m ÷ US$86m (Based on the trailing twelve months to March 2021).

The 'return' refers to a company's earnings over the last year. That means that for every $1 worth of shareholders' equity, the company generated $0.10 in profit.

What Has ROE Got To Do With 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. 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.

Deswell Industries' Earnings Growth And 9.6% ROE

At first glance, Deswell Industries' ROE doesn't look very promising. However, its ROE is similar to the industry average of 11%, so we won't completely dismiss the company. Particularly, the exceptional 22% net income growth seen by Deswell Industries over the past five years is pretty remarkable. Taking into consideration that the ROE is not particularly high, we reckon that there could also be other factors at play which could be influencing the company's growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

We then compared Deswell Industries' net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 11% in the same period.

past-earnings-growth — NasdaqGM:DSWL Past Earnings Growth June 12th 2021

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. Is Deswell Industries fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Deswell Industries Using Its Retained Earnings Effectively?

The three-year median payout ratio for Deswell Industries is 37%, which is moderately low. The company is retaining the remaining 63%. By the looks of it, the dividend is well covered and Deswell Industries is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.

Moreover, Deswell Industries is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years.

Conclusion

Overall, we feel that Deswell Industries certainly does have some positive factors to consider. Even in spite of the low rate of return, the company has posted impressive earnings growth as a result of reinvesting heavily into its business. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. To know the 3 risks we have identified for Deswell Industries visit our risks dashboard for free.

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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