Can Mixed Fundamentals Have A Negative Impact on H & M Hennes & Mauritz AB (publ) (STO:HM B) Current Share Price Momentum?

Most readers would already be aware that H & M Hennes & Mauritz's (STO:HM B) stock increased significantly by 30% over the past three months. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. Specifically, we decided to study H & M Hennes & Mauritz's ROE in this article.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for H & M Hennes & Mauritz

How Do You Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for H & M Hennes & Mauritz is:

20% = kr9.4b ÷ kr47b (Based on the trailing twelve months to February 2024).

The 'return' is the yearly profit. One way to conceptualize this is that for each SEK1 of shareholders' capital it has, the company made SEK0.20 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

H & M Hennes & Mauritz's Earnings Growth And 20% ROE

At first glance, H & M Hennes & Mauritz seems to have a decent ROE. Further, the company's ROE compares quite favorably to the industry average of 8.7%. For this reason, H & M Hennes & Mauritz's five year net income decline of 9.9% raises the question as to why the high ROE didn't translate into earnings growth. Therefore, 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 H & M Hennes & Mauritz'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 9.0% over the last few years.

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. Is HM B fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is H & M Hennes & Mauritz Making Efficient Use Of Its Profits?

H & M Hennes & Mauritz's high three-year median payout ratio of 120% suggests that the company is depleting its resources to keep up its dividend payments, and this shows in its shrinking earnings. Paying a dividend higher than reported profits is not a sustainable move.

Additionally, H & M Hennes & Mauritz 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. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 78% over the next three years. As a result, the expected drop in H & M Hennes & Mauritz's payout ratio explains the anticipated rise in the company's future ROE to 31%, over the same period.

Conclusion

In total, we're a bit ambivalent about H & M Hennes & Mauritz's performance. In spite of the high ROE, the company has failed to see growth in its earnings due to it paying out most of its profits as dividend, with almost nothing left to invest into its own business. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. 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.