Are Strong Financial Prospects The Force That Is Driving The Momentum In Hester Biosciences Limited's NSE:HESTERBIO) Stock?

Hester Biosciences' (NSE:HESTERBIO) stock is up by a considerable 34% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Specifically, we decided to study Hester Biosciences' ROE in this article.

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.

Check out our latest analysis for Hester Biosciences

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 Hester Biosciences is:

14% = ₹280m ÷ ₹2.1b (Based on the trailing twelve months to June 2020).

The 'return' is the yearly profit. One way to conceptualize this is that for each ₹1 of shareholders' capital it has, the company made ₹0.14 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. 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 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.

A Side By Side comparison of Hester Biosciences' Earnings Growth And 14% ROE

When you first look at it, Hester Biosciences' ROE doesn't look that attractive. However, the fact that the its ROE is quite higher to the industry average of 8.7% doesn't go unnoticed by us. This probably goes some way in explaining Hester Biosciences' moderate 12% growth over the past five years amongst other factors. Bear in mind, the company does have a moderately low ROE. It is just that the industry ROE is lower. Hence there might be some other aspects that are causing earnings to grow. For example, it is possible that the broader industry is going through a high growth phase, or that the company has a low payout ratio.

We then performed a comparison between Hester Biosciences' net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 12% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. 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 Hester Biosciences is trading on a high P/E or a low P/E, relative to its industry.

Is Hester Biosciences Efficiently Re-investing Its Profits?

In Hester Biosciences' case, its respectable earnings growth can probably be explained by its low three-year median payout ratio of 23% (or a retention ratio of 77%), which suggests that the company is investing most of its profits to grow its business.

Moreover, Hester Biosciences 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.

Summary

On the whole, we feel that Hester Biosciences' performance has been quite good. In particular, it's great to see that the company has seen significant growth in its earnings backed by a respectable ROE and a high reinvestment rate. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Not to forget, share price outcomes are also dependent on the potential risks a company may face. So it is important for investors to be aware of the risks involved in the business. To know the 3 risks we have identified for Hester Biosciences visit our risks dashboard for free.

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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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