Hong Leong Industries Berhad (KLSE:HLIND) has had a great run on the share market with its stock up by a significant 13% over the last three months. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. Particularly, we will be paying attention to Hong Leong Industries Berhad'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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.
How Is ROE Calculated?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Hong Leong Industries Berhad is:
13% = RM259m ÷ RM2.0b (Based on the trailing twelve months to December 2020).
The 'return' refers to a company's earnings over the last year. So, this means that for every MYR1 of its shareholder's investments, the company generates a profit of MYR0.13.
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. 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.
Hong Leong Industries Berhad's Earnings Growth And 13% ROE
At first glance, Hong Leong Industries Berhad seems to have a decent ROE. On comparing with the average industry ROE of 6.3% the company's ROE looks pretty remarkable. Yet, Hong Leong Industries Berhad has posted measly growth of 3.1% over the past five years. This is generally not the case as when a company has a high rate of return it should usually also have a high earnings growth rate. Such a scenario is likely to take place when a company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.
Next, on comparing with the industry net income growth, we found that the growth figure reported by Hong Leong Industries Berhad compares quite favourably to the industry average, which shows a decline of 2.6% 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. 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 Hong Leong Industries Berhad is trading on a high P/E or a low P/E, relative to its industry.
Is Hong Leong Industries Berhad Efficiently Re-investing Its Profits?
While Hong Leong Industries Berhad has a decent three-year median payout ratio of 43% (or a retention ratio of 57%), it has seen very little growth in earnings. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.
Additionally, Hong Leong Industries Berhad has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth.
Overall, we are quite pleased with Hong Leong Industries Berhad's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. 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. Not to forget, share price outcomes are also dependent on the potential risks a company may face. So it is important for investors to be aware of the risks involved in the business. Our risks dashboard would have the 2 risks we have identified for Hong Leong Industries Berhad.
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This article by Simply Wall St is general in nature. 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.
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