Holmarc Opto-Mechatronics Limited's (NSE:HOLMARC) Fundamentals Look Pretty Strong: Could The Market Be Wrong About The Stock?

With its stock down 14% over the past three months, it is easy to disregard Holmarc Opto-Mechatronics (NSE:HOLMARC). 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. In this article, we decided to focus on Holmarc Opto-Mechatronics' ROE.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

See our latest analysis for Holmarc Opto-Mechatronics

How Do You Calculate Return On Equity?

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 Holmarc Opto-Mechatronics is:

15% = ₹36m ÷ ₹247m (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 ₹0.15 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.

Holmarc Opto-Mechatronics' Earnings Growth And 15% ROE

When you first look at it, Holmarc Opto-Mechatronics' ROE doesn't look that attractive. However, the fact that the its ROE is quite higher to the industry average of 11% doesn't go unnoticed by us. Especially when you consider Holmarc Opto-Mechatronics' exceptional 28% net income growth over the past five years. Bear in mind, the company does have a moderately low ROE. It is just that the industry ROE is lower. Therefore, the growth in earnings could also be the result of other factors. E.g the company has a low payout ratio or could belong to a high growth industry.

Next, on comparing Holmarc Opto-Mechatronics' net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 29% over the last few years.

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. 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 Holmarc Opto-Mechatronics is trading on a high P/E or a low P/E, relative to its industry.

Is Holmarc Opto-Mechatronics Using Its Retained Earnings Effectively?

Holmarc Opto-Mechatronics' ' three-year median payout ratio is on the lower side at 10% implying that it is retaining a higher percentage (90%) of its profits. So it looks like Holmarc Opto-Mechatronics is reinvesting profits heavily to grow its business, which shows in its earnings growth.

While Holmarc Opto-Mechatronics has seen growth in its earnings, it only recently started to pay a dividend. It is most likely that the company decided to impress new and existing shareholders with a dividend.

Conclusion

In total, we are pretty happy with Holmarc Opto-Mechatronics' performance. Specifically, we like that it has been reinvesting a high portion of its profits at a moderate rate of return, resulting in earnings expansion. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Remember, the price of a stock is also dependent on the perceived risk. Therefore investors must keep themselves informed about the risks involved before investing in any company. You can see the 4 risks we have identified for Holmarc Opto-Mechatronics 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. 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.