Are H2O Innovation Inc.'s (TSE:HEO) Fundamentals Good Enough to Warrant Buying Given The Stock's Recent Weakness?

With its stock down 17% over the past three months, it is easy to disregard H2O Innovation (TSE:HEO). However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. In this article, we decided to focus on H2O Innovation'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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for H2O Innovation

How Is ROE Calculated?

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 H2O Innovation is:

3.3% = CA$3.4m ÷ CA$103m (Based on the trailing twelve months to March 2023).

The 'return' refers to a company's earnings over the last year. That means that for every CA$1 worth of shareholders' equity, the company generated CA$0.03 in profit.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.

H2O Innovation's Earnings Growth And 3.3% ROE

As you can see, H2O Innovation's ROE looks pretty weak. Not just that, even compared to the industry average of 8.1%, the company's ROE is entirely unremarkable. In spite of this, H2O Innovation was able to grow its net income considerably, at a rate of 59% in the last five years. We believe that there might be other aspects that are positively influencing the company's earnings growth. Such as - high earnings retention or an efficient management in place.

As a next step, we compared H2O Innovation's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 22%.

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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Has the market priced in the future outlook for HEO? You can find out in our latest intrinsic value infographic research report.

Is H2O Innovation Making Efficient Use Of Its Profits?

Given that H2O Innovation doesn't pay any dividend to its shareholders, we infer that the company has been reinvesting all of its profits to grow its business.

Summary

On the whole, we do feel that H2O Innovation has some positive attributes. Despite its low rate of return, the fact that the company reinvests a very high portion of its profits into its business, no doubt contributed to its high earnings growth. We also studied the latest analyst forecasts and found that the company's earnings growth is expected be similar to its current growth rate. 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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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.