Will Weakness in The Hour Glass Limited's (SGX:AGS) Stock Prove Temporary Given Strong Fundamentals?

It is hard to get excited after looking at Hour Glass' (SGX:AGS) recent performance, when its stock has declined 16% over the past three months. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Particularly, we will be paying attention to Hour Glass' ROE today.

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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for Hour Glass

How Is ROE Calculated?

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 Hour Glass is:

22% = S$174m ÷ S$788m (Based on the trailing twelve months to March 2023).

The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each SGD1 of shareholders' capital it has, the company made SGD0.22 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. 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.

Hour Glass' Earnings Growth And 22% ROE

Firstly, we acknowledge that Hour Glass has a significantly high ROE. Secondly, even when compared to the industry average of 9.2% the company's ROE is quite impressive. So, the substantial 26% net income growth seen by Hour Glass over the past five years isn't overly surprising.

Next, on comparing with the industry net income growth, we found that Hour Glass' growth is quite high when compared to the industry average growth of 16% in the same period, which is great to see.

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 Hour Glass is trading on a high P/E or a low P/E, relative to its industry.

Is Hour Glass Using Its Retained Earnings Effectively?

The three-year median payout ratio for Hour Glass is 36%, which is moderately low. The company is retaining the remaining 64%. By the looks of it, the dividend is well covered and Hour Glass is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.

Additionally, Hour Glass has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders.

Conclusion

Overall, we are quite pleased with Hour Glass' performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Let's not forget, business risk is also one of the factors that affects the price of the stock. So this is also an important area that investors need to pay attention to before making a decision on any business. You can see the 1 risk we have identified for Hour Glass by visiting our risks dashboard for free on our platform here.

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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.