Hammond Power Solutions Inc.'s (TSE:HPS.A) Fundamentals Look Pretty Strong: Could The Market Be Wrong About The Stock?

Hammond Power Solutions (TSE:HPS.A) has had a rough month with its share price down 16%. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Specifically, we decided to study Hammond Power Solutions' ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

View our latest analysis for Hammond Power Solutions

How Do You Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Hammond Power Solutions is:

25% = CA$68m ÷ CA$271m (Based on the trailing twelve months to September 2024).

The 'return' refers to a company's earnings over the last year. So, this means that for every CA$1 of its shareholder's investments, the company generates a profit of CA$0.25.

What Has ROE Got To Do With 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 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.

Hammond Power Solutions' Earnings Growth And 25% ROE

First thing first, we like that Hammond Power Solutions has an impressive ROE. Additionally, the company's ROE is higher compared to the industry average of 12% which is quite remarkable. Under the circumstances, Hammond Power Solutions' considerable five year net income growth of 40% was to be expected.

Next, on comparing with the industry net income growth, we found that Hammond Power Solutions' growth is quite high when compared to the industry average growth of 17% in the same period, which is great to see.

Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). 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 HPS.A? You can find out in our latest intrinsic value infographic research report.

Is Hammond Power Solutions Using Its Retained Earnings Effectively?

Hammond Power Solutions has a really low three-year median payout ratio of 13%, meaning that it has the remaining 87% left over to reinvest into its business. So it seems like the management is reinvesting profits heavily to grow its business and this reflects in its earnings growth number.

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.

Conclusion

On the whole, we feel that Hammond Power Solutions' performance has been quite good. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page 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.