Healthia Limited's (ASX:HLA) Stock is Soaring But Financials Seem Inconsistent: Will The Uptrend Continue?

Healthia (ASX:HLA) has had a great run on the share market with its stock up by a significant 72% over the last three months. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. In this article, we decided to focus on Healthia's ROE.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for Healthia

How Is ROE Calculated?

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 Healthia is:

8.9% = AU$5.1m ÷ AU$58m (Based on the trailing twelve months to June 2020).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.09.

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. 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.

Healthia's Earnings Growth And 8.9% ROE

On the face of it, Healthia's ROE is not much to talk about. Yet, a closer study shows that the company's ROE is similar to the industry average of 8.1%. But Healthia saw a five year net income decline of 33% over the past five years. Remember, the company's ROE is a bit low to begin with. Hence, this goes some way in explaining the shrinking earnings.

That being said, we compared Healthia'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 3.2% 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 Healthia is trading on a high P/E or a low P/E, relative to its industry.

Is Healthia Making Efficient Use Of Its Profits?

Looking at its three-year median payout ratio of 47% (or a retention ratio of 53%) which is pretty normal, Healthia's declining earnings is rather baffling as one would expect to see a fair bit of growth when a company is retaining a good portion of its profits. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.

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 38%. Still, forecasts suggest that Healthia's future ROE will rise to 12% even though the the company's payout ratio is not expected to change by much.

Summary

In total, we're a bit ambivalent about Healthia's performance. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. 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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