HomeChoice International plc (JSE:HIL) Stock Is Going Strong But Fundamentals Look Uncertain: What Lies Ahead ?

HomeChoice International (JSE:HIL) has had a great run on the share market with its stock up by a significant 59% over the last month. 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 HomeChoice International'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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

Check out our latest analysis for HomeChoice International

How To Calculate Return On Equity?

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 HomeChoice International is:

5.1% = R167m ÷ R3.3b (Based on the trailing twelve months to December 2021).

The 'return' is the profit over the last twelve months. That means that for every ZAR1 worth of shareholders' equity, the company generated ZAR0.05 in profit.

What Is The Relationship Between ROE And 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. 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.

HomeChoice International's Earnings Growth And 5.1% ROE

As you can see, HomeChoice International's ROE looks pretty weak. Not just that, even compared to the industry average of 11%, the company's ROE is entirely unremarkable. For this reason, HomeChoice International's five year net income decline of 19% is not surprising given its lower ROE. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

However, when we compared HomeChoice International's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 17% in the same period. This is quite worrisome.

Earnings growth is an important metric to consider when valuing a stock. 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. 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 HomeChoice International is trading on a high P/E or a low P/E, relative to its industry.

Is HomeChoice International Making Efficient Use Of Its Profits?

Looking at its three-year median payout ratio of 28% (or a retention ratio of 72%) which is pretty normal, HomeChoice International's declining earnings is rather baffling as one would expect to see a fair bit of growth when a company is retaining a good portion of its profits. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Additionally, HomeChoice International has paid dividends over a period of seven years, which means that the company's management is rather focused on keeping up its dividend payments, regardless of the shrinking earnings.

Conclusion

On the whole, we feel that the performance shown by HomeChoice International can be open to many interpretations. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. You can see the 3 risks we have identified for HomeChoice International 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.