Are Poor Financial Prospects Dragging Down Harvey Norman Holdings Limited (ASX:HVN Stock?

It is hard to get excited after looking at Harvey Norman Holdings' (ASX:HVN) recent performance, when its stock has declined 4.7% over the past three months. We decided to study the company's financials to determine if the downtrend will continue as the long-term performance of a company usually dictates market outcomes. Specifically, we decided to study Harvey Norman Holdings' ROE in this article.

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Harvey Norman Holdings

How Do You 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 Harvey Norman Holdings is:

7.9% = AU$358m ÷ AU$4.5b (Based on the trailing twelve months to June 2024).

The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every A$1 worth of equity, the company was able to earn A$0.08 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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.

Harvey Norman Holdings' Earnings Growth And 7.9% ROE

On the face of it, Harvey Norman Holdings' ROE is not much to talk about. However, its ROE is similar to the industry average of 7.9%, so we won't completely dismiss the company. Still, Harvey Norman Holdings has seen a flat net income growth over the past five years. Remember, the company's ROE is not particularly great to begin with. Hence, this provides some context to the flat earnings growth seen by the company.

As a next step, we compared Harvey Norman Holdings' net income growth with the industry and discovered that the industry saw an average growth of 7.6% in the same period.

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. Has the market priced in the future outlook for HVN? You can find out in our latest intrinsic value infographic research report.

Is Harvey Norman Holdings Using Its Retained Earnings Effectively?

With a high three-year median payout ratio of 56% (implying that the company keeps only 44% of its income) of its business to reinvest into its business), most of Harvey Norman Holdings' profits are being paid to shareholders, which explains the absence of growth in earnings.

Moreover, Harvey Norman Holdings 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. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 75% over the next three years. Regardless, the future ROE for Harvey Norman Holdings is speculated to rise to 10% despite the anticipated increase in the payout ratio. There could probably be other factors that could be driving the future growth in the ROE.

Summary

On the whole, Harvey Norman Holdings' performance is quite a big let-down. The company has seen a lack of earnings growth as a result of retaining very little profits and whatever little it does retain, is being reinvested at a very low rate of return. 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. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.