Harvey Norman Holdings' (ASX:HVN) stock up by 9.3% over the past three months. Since the market usually pay for a company’s long-term financial health, we decided to study the company’s fundamentals to see if they could be influencing the market. In this article, we decided to focus on Harvey Norman Holdings' 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.
How Is ROE Calculated?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Harvey Norman Holdings is:
14% = AU$486m ÷ AU$3.5b (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$0.14.
Why Is ROE Important For Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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 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 14% ROE
At first glance, Harvey Norman Holdings seems to have a decent ROE. Especially when compared to the industry average of 6.4% the company's ROE looks pretty impressive. Probably as a result of this, Harvey Norman Holdings was able to see a decent growth of 6.1% over the last five years.
Next, on comparing with the industry net income growth, we found that Harvey Norman Holdings' growth is quite high when compared to the industry average growth of 0.7% in the same period, which is great to see.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. What is HVN worth today? The intrinsic value infographic in our free research report helps visualize whether HVN is currently mispriced by the market.
Is Harvey Norman Holdings Efficiently Re-investing Its Profits?
The high three-year median payout ratio of 78% (or a retention ratio of 22%) for Harvey Norman Holdings suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.
Besides, Harvey Norman Holdings has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. 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 78%. Accordingly, forecasts suggest that Harvey Norman Holdings' future ROE will be 12% which is again, similar to the current ROE.
In total, we are pretty happy with Harvey Norman Holdings' performance. Especially the high ROE, Which has contributed to the impressive growth seen in earnings. Despite the company reinvesting only a small portion of its profits, it still has managed to grow its earnings so that is appreciable. Having said that, on studying current analyst estimates, we were concerned to see that while the company has grown its earnings in the past, analysts expect its earnings to shrink 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. 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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