Are Robust Financials Driving The Recent Rally In HMS Networks AB (publ)'s (STO:HMS) Stock?

Most readers would already be aware that HMS Networks' (STO:HMS) stock increased significantly by 32% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on HMS Networks' ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for HMS Networks

How To Calculate Return On Equity?

The formula for return on equity is:

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

So, based on the above formula, the ROE for HMS Networks is:

33% = kr612m ÷ kr1.9b (Based on the trailing twelve months to September 2023).

The 'return' is the yearly profit. One way to conceptualize this is that for each SEK1 of shareholders' capital it has, the company made SEK0.33 in profit.

What Has ROE Got To Do With 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.

HMS Networks' Earnings Growth And 33% ROE

Firstly, we acknowledge that HMS Networks has a significantly high ROE. Additionally, the company's ROE is higher compared to the industry average of 17% which is quite remarkable. So, the substantial 29% net income growth seen by HMS Networks over the past five years isn't overly surprising.

Next, on comparing with the industry net income growth, we found that HMS Networks' reported growth was lower than the industry growth of 50% over the last few years, which is not something we like to see.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about HMS Networks''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is HMS Networks Making Efficient Use Of Its Profits?

The three-year median payout ratio for HMS Networks is 34%, which is moderately low. The company is retaining the remaining 66%. So it seems that HMS Networks is reinvesting efficiently in a way that it sees impressive growth in its earnings (discussed above) and pays a dividend that's well covered.

Besides, HMS Networks has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 48% over the next three years. Accordingly, the expected increase in the payout ratio explains the expected decline in the company's ROE to 24%, over the same period.

Conclusion

Overall, we are quite pleased with HMS Networks' performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. As a result, the decent growth in its earnings is not surprising. With that said, on studying the latest analyst forecasts, we found that while the company has seen growth in its past earnings, analysts expect its future earnings to shrink. 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. 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.