Dr. Hönle AG (ETR:HNL) Stock's Been Sliding But Fundamentals Look Decent: Will The Market Correct The Share Price In The Future?

Dr. Hönle (ETR:HNL) has had a rough three months with its share price down 4.7%. But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. Specifically, we decided to study Dr. Hönle's ROE in this article.

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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

View our latest analysis for Dr. Hönle

How Do You Calculate Return On Equity?

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 Dr. Hönle is:

8.8% = €7.9m ÷ €90m (Based on the trailing twelve months to June 2020).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each €1 of shareholders' capital it has, the company made €0.09 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

Dr. Hönle's Earnings Growth And 8.8% ROE

To start with, Dr. Hönle's ROE looks acceptable. Yet, the fact that the company's ROE is lower than the industry average of 14% does temper our expectations. However, the moderate 9.6% net income growth seen by Dr. Hönle over the past five years is definitely a positive. We reckon that there could be other factors at play here. For instance, the company has a low payout ratio or is being managed efficiently. However, not to forget, the company does have a decent ROE to begin with, just that it is lower than the industry average. So this also does lend some color to the fairly high earnings growth seen by the company.

Next, on comparing with the industry net income growth, we found that Dr. Hönle's reported growth was lower than the industry growth of 44% in the same period, which is not something we like 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. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Dr. Hönle is trading on a high P/E or a low P/E, relative to its industry.

Is Dr. Hönle Efficiently Re-investing Its Profits?

Dr. Hönle has a three-year median payout ratio of 26%, which implies that it retains the remaining 74% of its profits. This suggests that its dividend is well covered, and given the decent growth seen by the company, it looks like management is reinvesting its earnings efficiently.

Additionally, Dr. Hönle has paid dividends over a period of eight years which means that the company is pretty serious about sharing its profits with shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 36% over the next three years. Regardless, the future ROE for Dr. Hönle is speculated to rise to 13% 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

In total, it does look like Dr. Hönle has some positive aspects to its business. Particularly, its earnings have grown respectably as we saw earlier, which was likely achieved due to the company reinvesting most of its earnings at a decent rate of return, to grow its business. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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. 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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