Could The Market Be Wrong About Hammond Power Solutions Inc. (TSE:HPS.A) Given Its Attractive Financial Prospects?

By
Simply Wall St
Published
May 21, 2021
TSX:HPS.A
Source: Shutterstock

It is hard to get excited after looking at Hammond Power Solutions' (TSE:HPS.A) recent performance, when its stock has declined 7.9% over the past month. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Specifically, we decided to study Hammond Power Solutions' 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.

View our latest analysis for Hammond Power Solutions

How Do You Calculate Return On Equity?

ROE 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 Hammond Power Solutions is:

12% = CA$14m ÷ CA$115m (Based on the trailing twelve months to March 2021).

The 'return' is the yearly profit. That means that for every CA$1 worth of shareholders' equity, the company generated CA$0.12 in profit.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. 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.

A Side By Side comparison of Hammond Power Solutions' Earnings Growth And 12% ROE

To begin with, Hammond Power Solutions seems to have a respectable ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 13%. This probably goes some way in explaining Hammond Power Solutions' significant 25% net income growth over the past five years amongst other factors. We believe that there might also be other aspects that are positively influencing the company's earnings growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

We then performed a comparison between Hammond Power Solutions' net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 23% in the same period.

past-earnings-growth
TSX:HPS.A Past Earnings Growth May 22nd 2021

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. If you're wondering about Hammond Power Solutions''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Hammond Power Solutions Efficiently Re-investing Its Profits?

Hammond Power Solutions has a three-year median payout ratio of 28% (where it is retaining 72% of its income) which is not too low or not too high. By the looks of it, the dividend is well covered and Hammond Power Solutions is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.

Moreover, Hammond Power Solutions is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years.

Summary

On the whole, we feel that Hammond Power Solutions' performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Let's not forget, business risk is also one of the factors that affects the price of the stock. So this is also an important area that investors need to pay attention to before making a decision on any business. To know the 3 risks we have identified for Hammond Power Solutions visit our risks dashboard for free.

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