Stock Analysis

Is Hotel Property Investments' (ASX:HPI) Recent Price Movement Underpinned By Its Weak Fundamentals?

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ASX:HPI
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Hotel Property Investments (ASX:HPI) has had a rough month with its share price down 7.6%. It is possible that the markets have ignored the company's differing financials and decided to lean-in to the negative sentiment. Fundamentals usually dictate market outcomes so it makes sense to study the company's financials. Specifically, we decided to study Hotel Property Investments' 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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Hotel Property Investments

How To Calculate Return On Equity?

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 Hotel Property Investments is:

8.7% = AU$41m ÷ AU$472m (Based on the trailing twelve months to June 2020).

The 'return' is the profit over the last twelve months. That means that for every A$1 worth of shareholders' equity, the company generated A$0.09 in profit.

Why Is ROE Important For 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 all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

A Side By Side comparison of Hotel Property Investments' Earnings Growth And 8.7% ROE

On the face of it, Hotel Property Investments' ROE is not much to talk about. However, the fact that the its ROE is quite higher to the industry average of 6.6% doesn't go unnoticed by us. However, Hotel Property Investments' five year net income decline rate was 7.1%. Remember, the company's ROE is a bit low to begin with, just that it is higher than the industry average. Therefore, the decline in earnings could also be the result of this.

However, when we compared Hotel Property Investments' growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 8.4% in the same period. This is quite worrisome.

past-earnings-growth
ASX:HPI Past Earnings Growth January 22nd 2021

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. Has the market priced in the future outlook for HPI? You can find out in our latest intrinsic value infographic research report.

Is Hotel Property Investments Making Efficient Use Of Its Profits?

Hotel Property Investments seems to be paying out most of its income as dividends judging by its three-year median payout ratio of 54% (meaning, the company retains only 46% of profits). However, this is typical for REITs as they are often required by law to distribute most of their earnings. Accordingly, this likely explains why its earnings have been shrinking.

Additionally, Hotel Property Investments has paid dividends over a period of six years, which means that the company's management is rather focused on keeping up its dividend payments, regardless of the shrinking earnings. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 98% over the next three years. Therefore, the expected rise in the payout ratio explains why the company's ROE is expected to decline to 6.7% over the same period.

Summary

On the whole, we feel that the performance shown by Hotel Property Investments can be open to many interpretations. Specifically, the low earnings growth is a bit concerning, especially given that the company has a respectable rate of return. Investors may have benefitted, had the company been reinvesting more of its earnings. As discussed earlier, the company is retaining a small portion of its profits. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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