Most readers would already be aware that HNI’s (NYSE:HNI) stock increased significantly by 30% 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 HNI’s ROE.
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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
See our latest analysis for HNI
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 HNI is:
15% = US$82m ÷ US$553m (Based on the trailing twelve months to June 2020).
The ‘return’ refers to a company’s earnings over the last year. One way to conceptualize this is that for each $1 of shareholders’ capital it has, the company made $0.15 in profit.
What Has ROE Got To Do With Earnings Growth?
So far, we’ve learned that ROE is a measure of a company’s profitability. 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. 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.
HNI’s Earnings Growth And 15% ROE
To begin with, HNI seems to have a respectable ROE. Even when compared to the industry average of 12% the company’s ROE looks quite decent. Given the circumstances, we can’t help but wonder why HNI saw little to no growth in the past five years. So, there could be some other aspects that could potentially be preventing the company from growing. These include low earnings retention or poor allocation of capital.
Next, on comparing with the industry net income growth, we found that HNI’s reported growth was lower than the industry growth of 16% in the same period, which is not something we like to see.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company’s expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is HNI fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is HNI Using Its Retained Earnings Effectively?
The high three-year median payout ratio of 56% (meaning, the company retains only 44% of profits) for HNI suggests that the company’s earnings growth was miniscule as a result of paying out a majority of its earnings.
Moreover, HNI 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.
Summary
Overall, we feel that HNI certainly does have some positive factors to consider. 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 analyst forecasts show that the company will continue to see an expansion in its earnings. Are these analysts expectations based on the broad expectations for the industry, or on the company’s fundamentals? Click here to be taken to our analyst’s forecasts page 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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