With its stock down 13% over the past three months, it is easy to disregard Honda India Power Products (NSE:HONDAPOWER). It is possible that the markets have ignored the company's differing financials and decided to lean-in to the negative sentiment. Stock prices are usually driven by a company’s financial performance over the long term, and therefore we decided to pay more attention to the company's financial performance. In this article, we decided to focus on Honda India Power Products' ROE.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.
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 Honda India Power Products is:
12% = ₹742m ÷ ₹6.3b (Based on the trailing twelve months to December 2021).
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 ₹0.12.
Why Is ROE Important For Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 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 Honda India Power Products' Earnings Growth And 12% ROE
On the face of it, Honda India Power Products' ROE is not much to talk about. Yet, a closer study shows that the company's ROE is similar to the industry average of 13%. However, Honda India Power Products has seen a flattish net income growth over the past five years, which is not saying much. Remember, the company's ROE is not particularly great to begin with. So that could also be one of the reasons behind the company's flat growth in earnings.
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 13% 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). Doing so will help them establish if the stock's future looks promising or ominous. Is Honda India Power Products fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Honda India Power Products Efficiently Re-investing Its Profits?
Honda India Power Products' low three-year median payout ratio of 19%, (meaning the company retains81% of profits) should mean that the company is retaining most of its earnings and consequently, should see higher growth than it has reported.
Additionally, Honda India Power Products 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.
On the whole, we feel that the performance shown by Honda India Power Products can be open to many interpretations. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. Until now, we have only just grazed the surface of the company's past performance by looking at the company's fundamentals. So it may be worth checking this free detailed graph of Honda India Power Products' past earnings, as well as revenue and cash flows to get a deeper insight into the company's performance.
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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.