Will Weakness in Hindustan Unilever Limited's (NSE:HINDUNILVR) Stock Prove Temporary Given Strong Fundamentals?

With its stock down 5.0% over the past three months, it is easy to disregard Hindustan Unilever (NSE:HINDUNILVR). But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Particularly, we will be paying attention to Hindustan Unilever's ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for Hindustan Unilever

How Is ROE Calculated?

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 Hindustan Unilever is:

20% = ₹98b ÷ ₹496b (Based on the trailing twelve months to December 2022).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each ₹1 of shareholders' capital it has, the company made ₹0.20 in profit.

What Is The Relationship Between ROE And 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 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 Hindustan Unilever's Earnings Growth And 20% ROE

To start with, Hindustan Unilever's ROE looks acceptable. Further, the company's ROE compares quite favorably to the industry average of 16%. Probably as a result of this, Hindustan Unilever was able to see a decent growth of 13% over the last five years.

As a next step, we compared Hindustan Unilever's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 5.2%.

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. 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 Hindustan Unilever is trading on a high P/E or a low P/E, relative to its industry.

Is Hindustan Unilever Using Its Retained Earnings Effectively?

Hindustan Unilever has a significant three-year median payout ratio of 88%, meaning that it is left with only 12% to reinvest into its business. This implies that the company has been able to achieve decent earnings growth despite returning most of its profits to shareholders.

Moreover, Hindustan Unilever 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. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 74%. Still, forecasts suggest that Hindustan Unilever's future ROE will rise to 26% even though the the company's payout ratio is not expected to change by much.

Conclusion

On the whole, we feel that Hindustan Unilever's performance has been quite good. In particular, its high ROE is quite noteworthy and also the probable explanation behind its considerable earnings growth. Yet, the company is retaining a small portion of its profits. Which means that the company has been able to grow its earnings in spite of it, so that's not too bad. On studying current analyst estimates, we found that analysts expect the company to continue its recent growth streak. 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.