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

HFCL (NSE:HFCL) has had a rough week with its share price down 6.1%. 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. In this article, we decided to focus on HFCL's 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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for HFCL

How Is ROE Calculated?

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 HFCL is:

8.4% = ₹3.4b ÷ ₹40b (Based on the trailing twelve months to March 2024).

The 'return' is the profit over the last twelve months. So, this means that for every ₹1 of its shareholder's investments, the company generates a profit of ₹0.08.

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.

HFCL's Earnings Growth And 8.4% ROE

It is quite clear that HFCL's ROE is rather low. Not just that, even compared to the industry average of 22%, the company's ROE is entirely unremarkable. HFCL was still able to see a decent net income growth of 7.2% over the past five years. We believe that there might be other aspects that are positively influencing the company's earnings growth. Such as - high earnings retention or an efficient management in place.

We then compared HFCL's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 27% 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. 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 HFCL is trading on a high P/E or a low P/E, relative to its industry.

Is HFCL Making Efficient Use Of Its Profits?

HFCL has a low three-year median payout ratio of 8.6%, meaning that the company retains the remaining 91% of its profits. This suggests that the management is reinvesting most of the profits to grow the business.

Additionally, HFCL has paid dividends over a period of six years which means that the company is pretty serious about sharing its profits with shareholders.

Conclusion

In total, it does look like HFCL has some positive aspects to its business. That is, a decent growth in earnings backed by a high rate of reinvestment. However, we do feel that that earnings growth could have been higher if the business were to improve on the low ROE rate. Especially given how the company is reinvesting a huge chunk of its profits. 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. Our risks dashboard would have the 2 risks we have identified for HFCL.

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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.