Hansen Technologies' (ASX:HSN) stock is up by a considerable 28% 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. Specifically, we decided to study Hansen Technologies' 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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
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 Hansen Technologies is:
10% = AU$26m ÷ AU$252m (Based on the trailing twelve months to June 2020).
The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$0.10 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. 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.
Hansen Technologies' Earnings Growth And 10% ROE
On the face of it, Hansen Technologies' ROE is not much to talk about. Next, when compared to the average industry ROE of 13%, the company's ROE leaves us feeling even less enthusiastic. Therefore, Hansen Technologies' flat earnings over the past five years can possibly be explained by the low ROE amongst other factors.
As a next step, we compared Hansen Technologies' net income growth with the industry and discovered that the industry saw an average growth of 11% in the same period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. What is HSN worth today? The intrinsic value infographic in our free research report helps visualize whether HSN is currently mispriced by the market.
Is Hansen Technologies Using Its Retained Earnings Effectively?
Despite having a normal three-year median payout ratio of 49% (implying that the company keeps 51% of its income) over the last three years, Hansen Technologies has seen a negligible amount of growth in earnings as we saw above. Therefore, there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.
Additionally, Hansen Technologies has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 39% over the next three years. As a result, the expected drop in Hansen Technologies' payout ratio explains the anticipated rise in the company's future ROE to 18%, over the same period.
Overall, we have mixed feelings about Hansen Technologies. 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.
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