Are Honda India Power Products Limited's (NSE:HONDAPOWER) Fundamentals Good Enough to Warrant Buying Given The Stock's Recent Weakness?

Honda India Power Products (NSE:HONDAPOWER) has had a rough three months with its share price down 8.1%. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. In this article, we decided to focus on Honda India Power Products' 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.

View our latest analysis for Honda India Power Products

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 Honda India Power Products is:

7.3% = ₹418m ÷ ₹5.7b (Based on the trailing twelve months to June 2020).

The 'return' is the income the business earned over the last year. Another way to think of that is that for every ₹1 worth of equity, the company was able to earn ₹0.07 in profit.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. 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.

Honda India Power Products' Earnings Growth And 7.3% ROE

It is quite clear that Honda India Power Products' ROE is rather low. An industry comparison shows that the company's ROE is not much different from the industry average of 8.5% either. As a result, Honda India Power Products' decent 5.2% net income growth seen over the past five years bodes well with us. Considering the low ROE, it is quite possible that there might also be some other aspects that are positively influencing the company's earnings growth. Such as - high earnings retention or an efficient management in place.

Next, on comparing with the industry net income growth, we found that Honda India Power Products' reported growth was lower than the industry growth of 8.6% 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. 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. Is Honda India Power Products fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Honda India Power Products Making Efficient Use Of Its Profits?

Honda India Power Products has a low three-year median payout ratio of 19%, meaning that the company retains the remaining 81% of its profits. This suggests that the management is reinvesting most of the profits to grow the business.

Moreover, Honda India Power Products 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.

Summary

In total, it does look like Honda India Power Products has some positive aspects to its business. Specifically, its fairly high earnings growth number, which no doubt was backed by the company's high earnings retention. Still, the low ROE means that all that reinvestment is not reaping a lot of benefit to the investors. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. You can see the 1 risk we have identified for Honda India Power Products by visiting our risks dashboard for free on our platform here.

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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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