Halwani Bros. Co. Ltd.'s (TADAWUL:6001) Stock Going Strong But Fundamentals Look Weak: What Implications Could This Have On The Stock?

Halwani Bros' (TADAWUL:6001) stock is up by a considerable 37% over the past three months. However, we decided to pay close attention to its weak financials as we are doubtful that the current momentum will keep up, given the scenario. In this article, we decided to focus on Halwani Bros' ROE.

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. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for Halwani Bros

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 Halwani Bros is:

17% = ر.س85m ÷ ر.س515m (Based on the trailing twelve months to September 2020).

The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each SAR1 of shareholders' capital it has, the company made SAR0.17 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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.

A Side By Side comparison of Halwani Bros' Earnings Growth And 17% ROE

On the face of it, Halwani Bros' ROE is not much to talk about. However, the fact that the company's ROE is higher than the average industry ROE of 12%, is definitely interesting. However, Halwani Bros' five year net income decline rate was 25%. Remember, the company's ROE is a bit low to begin with, just that it is higher than the industry average. Hence, this goes some way in explaining the shrinking earnings.

With the industry earnings declining at a rate of 26% in the same period, we deduce that both the company and the industry are shrinking at the same rate.

Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. What is 6001 worth today? The intrinsic value infographic in our free research report helps visualize whether 6001 is currently mispriced by the market.

Is Halwani Bros Efficiently Re-investing Its Profits?

Halwani Bros' high three-year median payout ratio of 112% suggests that the company is depleting its resources to keep up its dividend payments, and this shows in its shrinking earnings. Paying a dividend beyond their means is usually not viable over the long term. To know the 2 risks we have identified for Halwani Bros visit our risks dashboard for free.

Moreover, Halwani Bros has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 88% over the next three years. Despite the lower expected payout ratio, the company's ROE is not expected to change by much.

Conclusion

Overall, we would be extremely cautious before making any decision on Halwani Bros. While its ROE is pretty moderate, the company is retaining very little of its profits, meaning very little of its profits are being reinvested into the business. This explains the lack or absence of growth in its earnings. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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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