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High Liner Foods' (TSE:HLF) stock is up by 1.3% over the past month. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to investigate if the company's decent financials had a hand to play in the recent price move. Particularly, we will be paying attention to High Liner Foods' ROE today.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
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 High Liner Foods is:
10% = US$32m ÷ US$313m (Based on the trailing twelve months to April 2021).
The 'return' is the income the business earned over the last year. So, this means that for every CA$1 of its shareholder's investments, the company generates a profit of CA$0.10.
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.
High Liner Foods' Earnings Growth And 10% ROE
To begin with, High Liner Foods seems to have a respectable ROE. Even when compared to the industry average of 10% the company's ROE looks quite decent. For this reason, High Liner Foods' five year net income decline of 12% raises the question as to why the decent ROE didn't translate into growth. So, there might be some other aspects that could explain this. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.
That being said, we compared High Liner Foods' performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 4.4% in the same period.
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. Is High Liner Foods fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is High Liner Foods Using Its Retained Earnings Effectively?
High Liner Foods' declining earnings is not surprising given how the company is spending most of its profits in paying dividends, judging by its three-year median payout ratio of 50% (or a retention ratio of 50%). With only very little left to reinvest into the business, growth in earnings is far from likely. To know the 2 risks we have identified for High Liner Foods visit our risks dashboard for free.
In addition, High Liner Foods 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.
On the whole, we do feel that High Liner Foods has some positive attributes. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE. Bear in mind, the company reinvests a small portion of its profits, which means that investors aren't reaping the benefits of the high rate of return. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. 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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