Halma plc's (LON:HLMA) Stock Is Going Strong: Is the Market Following Fundamentals?

Halma (LON:HLMA) has had a great run on the share market with its stock up by a significant 11% over the last month. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on Halma's ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Halma

How Is ROE Calculated?

The formula for return on equity is:

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

So, based on the above formula, the ROE for Halma is:

16% = UK£177m ÷ UK£1.1b (Based on the trailing twelve months to September 2020).

The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every £1 worth of equity, the company was able to earn £0.16 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. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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 Halma's Earnings Growth And 16% ROE

To start with, Halma's ROE looks acceptable. Especially when compared to the industry average of 8.8% the company's ROE looks pretty impressive. This certainly adds some context to Halma's decent 12% net income growth seen over the past five years.

Next, on comparing with the industry net income growth, we found that Halma's reported growth was lower than the industry growth of 17% in the same period, which is not something we like to see.

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). This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Halma's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Halma Using Its Retained Earnings Effectively?

Halma has a healthy combination of a moderate three-year median payout ratio of 35% (or a retention ratio of 65%) and a respectable amount of growth in earnings as we saw above, meaning that the company has been making efficient use of its profits.

Besides, Halma has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 31%. As a result, Halma's ROE is not expected to change by much either, which we inferred from the analyst estimate of 17% for future ROE.

Summary

Overall, we are quite pleased with Halma's performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. As a result, the decent growth in its earnings is not surprising. We also studied the latest analyst forecasts and found that the company's earnings growth is expected be similar to its current growth rate. 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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