Hap Seng Consolidated Berhad's (KLSE:HAPSENG) Stock Has Shown Weakness Lately But Financial Prospects Look Decent: Is The Market Wrong?

Hap Seng Consolidated Berhad (KLSE:HAPSENG) has had a rough three months with its share price down 34%. 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. Particularly, we will be paying attention to Hap Seng Consolidated Berhad's ROE today.

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Hap Seng Consolidated Berhad

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 Hap Seng Consolidated Berhad is:

12% = RM1.1b ÷ RM9.0b (Based on the trailing twelve months to December 2022).

The 'return' refers to a company's earnings over the last year. That means that for every MYR1 worth of shareholders' equity, the company generated MYR0.12 in profit.

What Has ROE Got To Do With 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 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 Hap Seng Consolidated Berhad's Earnings Growth And 12% ROE

To start with, Hap Seng Consolidated Berhad's ROE looks acceptable. Even when compared to the industry average of 11% the company's ROE looks quite decent. However, while Hap Seng Consolidated Berhad has a pretty respectable ROE, its five year net income decline rate was 3.2% . So, there might be some other aspects that could explain this. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.

So, as a next step, we compared Hap Seng Consolidated Berhad's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 7.9% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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 Hap Seng Consolidated Berhad is trading on a high P/E or a low P/E, relative to its industry.

Is Hap Seng Consolidated Berhad Efficiently Re-investing Its Profits?

With a high three-year median payout ratio of 81% (implying that 19% of the profits are retained), most of Hap Seng Consolidated Berhad's profits are being paid to shareholders, which explains the company's shrinking earnings. The business is only left with a small pool of capital to reinvest - A vicious cycle that doesn't benefit the company in the long-run. You can see the 4 risks we have identified for Hap Seng Consolidated Berhad by visiting our risks dashboard for free on our platform here.

In addition, Hap Seng Consolidated Berhad has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth.

Conclusion

Overall, we feel that Hap Seng Consolidated Berhad certainly does have some positive factors to consider. However, while the company does have a high ROE, its earnings growth number is quite disappointing. This can be blamed on the fact that it reinvests only a small portion of its profits and pays out the rest as dividends. So far, we've only made a quick discussion around the company's earnings growth. To gain further insights into Hap Seng Consolidated Berhad's past profit growth, check out this visualization of past earnings, revenue and cash flows.

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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.