Is The Market Rewarding Hufvudstaden AB (publ) (STO:HUFV A) With A Negative Sentiment As A Result Of Its Mixed Fundamentals?

By
Simply Wall St
Published
January 11, 2022
OM:HUFV A
Source: Shutterstock

Hufvudstaden (STO:HUFV A) has had a rough three months with its share price down 4.7%. It seems that the market might have completely ignored the positive aspects of the company's fundamentals and decided to weigh-in more on the negative aspects. Long-term fundamentals are usually what drive market outcomes, so it's worth paying close attention. In this article, we decided to focus on Hufvudstaden's ROE.

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.

See our latest analysis for Hufvudstaden

How Do You 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 Hufvudstaden is:

2.8% = kr812m ÷ kr29b (Based on the trailing twelve months to September 2021).

The 'return' is the income the business earned over the last year. That means that for every SEK1 worth of shareholders' equity, the company generated SEK0.03 in profit.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

Hufvudstaden's Earnings Growth And 2.8% ROE

When you first look at it, Hufvudstaden's ROE doesn't look that attractive. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 16%. Therefore, it might not be wrong to say that the five year net income decline of 35% seen by Hufvudstaden was probably the result of it having a lower ROE. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. For example, it is possible that the business has allocated capital poorly or that the company has a very high payout ratio.

That being said, we compared Hufvudstaden's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 18% in the same period.

past-earnings-growth
OM:HUFV A Past Earnings Growth January 11th 2022

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. 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 Hufvudstaden is trading on a high P/E or a low P/E, relative to its industry.

Is Hufvudstaden Efficiently Re-investing Its Profits?

Hufvudstaden's low three-year median payout ratio of 24% (or a retention ratio of 76%) over the last three years should mean that the company is retaining most of its earnings to fuel its growth but the company's earnings have actually shrunk. The low payout should mean that the company is retaining most of its earnings and consequently, should see some growth. So there could be some other explanations in that regard. For example, the company's business may be deteriorating.

In addition, Hufvudstaden 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. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 75% over the next three years. Regardless, the future ROE for Hufvudstaden is speculated to rise to 4.3% despite the anticipated increase in the payout ratio. There could probably be other factors that could be driving the future growth in the ROE.

Conclusion

In total, we're a bit ambivalent about Hufvudstaden's performance. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. 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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