Does Hon Hai Precision Industry Co., Ltd.'s (TWSE:2317) Weak Fundamentals Mean A Downturn In Its Stock Should Be Expected?

Hon Hai Precision Industry's (TWSE:2317) stock is up by 1.5% over the past three months. Given that the markets usually pay for the long-term financial health of a company, we wonder if the current momentum in the share price will keep up, given that the company's financials don't look very promising. In this article, we decided to focus on Hon Hai Precision Industry's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for Hon Hai Precision Industry

How To Calculate Return On Equity?

Return on equity 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 Hon Hai Precision Industry is:

8.4% = NT$142b ÷ NT$1.7t (Based on the trailing twelve months to September 2023).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each NT$1 of shareholders' capital it has, the company made NT$0.08 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 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.

Hon Hai Precision Industry's Earnings Growth And 8.4% ROE

At first glance, Hon Hai Precision Industry's ROE doesn't look very promising. However, given that the company's ROE is similar to the average industry ROE of 8.9%, we may spare it some thought. On the other hand, Hon Hai Precision Industry reported a fairly low 2.5% net income growth over the past five years. Remember, the company's ROE is not particularly great to begin with. Hence, this does provide some context to low earnings growth seen by the company.

Next, on comparing with the industry net income growth, we found that Hon Hai Precision Industry's reported growth was lower than the industry growth of 15% over the last few years, which is not something we like 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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Hon Hai Precision Industry fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Hon Hai Precision Industry Efficiently Re-investing Its Profits?

Hon Hai Precision Industry has a three-year median payout ratio of 52% (implying that it keeps only 48% of its profits), meaning that it pays out most of its profits to shareholders as dividends, and as a result, the company has seen low earnings growth.

In addition, Hon Hai Precision Industry 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 is expected to keep paying out approximately 50% of its profits over the next three years. As a result, Hon Hai Precision Industry's ROE is not expected to change by much either, which we inferred from the analyst estimate of 9.8% for future ROE.

Conclusion

Overall, we would be extremely cautious before making any decision on Hon Hai Precision Industry. The company has seen a lack of earnings growth as a result of retaining very little profits and whatever little it does retain, is being reinvested at a very low rate of return. 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 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.