Hexagon AB (publ)'s (STO:HEXA B) Stock Has Seen Strong Momentum: Does That Call For Deeper Study Of Its Financial Prospects?

Hexagon's (STO:HEXA B) stock is up by a considerable 8.5% over the past week. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. Specifically, we decided to study Hexagon's ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Hexagon

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 Hexagon is:

9.2% = €810m ÷ €8.8b (Based on the trailing twelve months to December 2021).

The 'return' is the yearly profit. Another way to think of that is that for every SEK1 worth of equity, the company was able to earn SEK0.09 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. 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.

Hexagon's Earnings Growth And 9.2% ROE

To start with, Hexagon's ROE looks acceptable. And on comparing with the industry, we found that the the average industry ROE is similar at 11%. Despite the modest returns, Hexagon's five year net income growth was quite low, averaging at only 4.8%. We reckon that a low growth, when returns are moderate could be the result of certain circumstances like low earnings retention or poor allocation of capital.

Next, on comparing with the industry net income growth, we found that Hexagon's reported growth was lower than the industry growth of 16% in the same period, which is not something we like to see.

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). Doing so will help them establish if the stock's future looks promising or ominous. Is HEXA B fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Hexagon Using Its Retained Earnings Effectively?

Despite having a moderate three-year median payout ratio of 32% (implying that the company retains the remaining 68% of its income), Hexagon's earnings growth was quite low. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

Additionally, Hexagon 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. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 30%. However, Hexagon's ROE is predicted to rise to 13% despite there being no anticipated change in its payout ratio.

Summary

In total, it does look like Hexagon has some positive aspects to its business. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.