Are Hero MotoCorp Limited's (NSE:HEROMOTOCO) Fundamentals Good Enough to Warrant Buying Given The Stock's Recent Weakness?

With its stock down 26% over the past three months, it is easy to disregard Hero MotoCorp (NSE:HEROMOTOCO). 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. Particularly, we will be paying attention to Hero MotoCorp's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Hero MotoCorp

How To 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 Hero MotoCorp is:

22% = ₹41b ÷ ₹191b (Based on the trailing twelve months to September 2024).

The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every ₹1 worth of equity, the company was able to earn ₹0.22 in profit.

Why Is ROE Important For 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 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 Hero MotoCorp's Earnings Growth And 22% ROE

To begin with, Hero MotoCorp seems to have a respectable ROE. Further, the company's ROE is similar to the industry average of 22%. Despite the moderate return on equity, Hero MotoCorp has posted a net income growth of 3.3% over the past five years. A few likely reasons that could be keeping earnings growth low are - the company has a high payout ratio or the business has allocated capital poorly, for instance.

We then compared Hero MotoCorp's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 28% in the same 5-year period, which is a bit concerning.

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

Is Hero MotoCorp Using Its Retained Earnings Effectively?

With a high three-year median payout ratio of 67% (or a retention ratio of 33%), most of Hero MotoCorp's profits are being paid to shareholders. This definitely contributes to the low earnings growth seen by the company.

Additionally, Hero MotoCorp has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 54% of its profits over the next three years. As a result, Hero MotoCorp's ROE is not expected to change by much either, which we inferred from the analyst estimate of 26% for future ROE.

Conclusion

On the whole, we do feel that Hero MotoCorp has some positive attributes. However, while the company does have a high ROE, its earnings growth number is quite disappointing. This can be blamed on the fact that it reinvests only a small portion of its profits and pays out the rest as dividends. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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.