- Oops!Something went wrong.Please try again later.
Most readers would already be aware that Héroux-Devtek's (TSE:HRX) stock increased significantly by 15% over the past three months. But the company's key financial indicators appear to be differing across the board and that makes us question whether or not the company's current share price momentum can be maintained. In this article, we decided to focus on Héroux-Devtek's ROE.
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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.
How Do You 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 Héroux-Devtek is:
5.1% = CA$20m ÷ CA$392m (Based on the trailing twelve months to March 2021).
The 'return' is the amount earned after tax over the last twelve months. That means that for every CA$1 worth of shareholders' equity, the company generated CA$0.05 in profit.
Why Is ROE Important For Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.
Héroux-Devtek's Earnings Growth And 5.1% ROE
On the face of it, Héroux-Devtek's ROE is not much to talk about. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 8.7%. Therefore, it might not be wrong to say that the five year net income decline of 43% seen by Héroux-Devtek was probably the result of it having a lower ROE. However, there could also be other factors causing the earnings to decline. For example, it is possible that the business has allocated capital poorly or that the company has a very high payout ratio.
Furthermore, even when compared to the industry, which has been shrinking its earnings at a rate 32% in the same period, we found that Héroux-Devtek's performance is pretty disappointing, as it suggests that the company has been shrunk its earnings at a rate faster than the industry.
Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. Has the market priced in the future outlook for HRX? You can find out in our latest intrinsic value infographic research report.
Is Héroux-Devtek Efficiently Re-investing Its Profits?
Overall, we have mixed feelings about Héroux-Devtek. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.
This article by Simply Wall St is general in nature. 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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.