Most readers would already be aware that Howden Joinery Group's (LON:HWDN) stock increased significantly by 23% over the past three months. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. In this article, we decided to focus on Howden Joinery Group'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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.
How To 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 Howden Joinery Group is:
23% = UK£136m ÷ UK£588m (Based on the trailing twelve months to June 2020).
The 'return' is the income the business earned over the last year. So, this means that for every £1 of its shareholder's investments, the company generates a profit of £0.23.
What Has ROE Got To Do With 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. 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.
A Side By Side comparison of Howden Joinery Group's Earnings Growth And 23% ROE
To begin with, Howden Joinery Group has a pretty high ROE which is interesting. Second, a comparison with the average ROE reported by the industry of 15% also doesn't go unnoticed by us. Given the circumstances, we can't help but wonder why Howden Joinery Group saw little to no growth in the past five years. Based on this, we feel that there might be other reasons which haven't been discussed so far in this article that could be hampering the company's growth. These include low earnings retention or poor allocation of capital
As a next step, we compared Howden Joinery Group's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 10% in the same period.
Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 Howden Joinery Group is trading on a high P/E or a low P/E, relative to its industry.
Is Howden Joinery Group Using Its Retained Earnings Effectively?
While the company did pay out a portion of its dividend in the past, it currently doesn't pay a dividend. We infer that the company has been reinvesting all of its profits to grow its business.
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 37%. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 26%.
In total, it does look like Howden Joinery Group has some positive aspects to its business. However, given the high ROE and high profit retention, we would expect the company to be delivering strong earnings growth, but that isn't the case here. This suggests that there might be some external threat to the business, that's hampering its growth. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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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Howden Joinery Group
Howden Joinery Group Plc, a trade kitchen supplier, provides various products across kitchens, joinery, and hardware in the United Kingdom, France, and Belgium.
Outstanding track record with flawless balance sheet and pays a dividend.