Is Weakness In HFCL Limited (NSE:HFCL) Stock A Sign That The Market Could be Wrong Given Its Strong Financial Prospects?

It is hard to get excited after looking at HFCL's (NSE:HFCL) recent performance, when its stock has declined 12% over the past three months. 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. Specifically, we decided to study HFCL's ROE in this article.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for HFCL

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 HFCL is:

16% = ₹3.4b ÷ ₹21b (Based on the trailing twelve months to December 2021).

The 'return' is the amount earned after tax over the last twelve months. That means that for every ₹1 worth of shareholders' equity, the company generated ₹0.16 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. 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 16% ROE

To begin with, HFCL seems to have a respectable ROE. On comparing with the average industry ROE of 9.9% the company's ROE looks pretty remarkable. This certainly adds some context to HFCL's decent 12% net income growth seen over the past five years.

We then performed a comparison between HFCL's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 10% in the same period.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about HFCL's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is HFCL Efficiently Re-investing Its Profits?

HFCL's three-year median payout ratio to shareholders is 5.7% (implying that it retains 94% of its income), which is on the lower side, so it seems like the management is reinvesting profits heavily to grow its business.

Moreover, HFCL is determined to keep sharing its profits with shareholders which we infer from its long history of four years of paying a dividend.

Summary

Overall, we are quite pleased with HFCL's performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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.