Yahoo Finance Howden Joinery Group Plc's (LON:HWDN) Stock Has Seen Strong Momentum: Does That Call For Deeper Study Of Its Financial Prospects?
Howden Joinery Group's (LON:HWDN) stock is up by a considerable 17% over the past three months. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. In this article, we decided to focus on Howden Joinery Group'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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
See our latest analysis for Howden Joinery Group
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 Howden Joinery Group is:
20% = UK£148m ÷ UK£721m (Based on the trailing twelve months to December 2020).
The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.20 in profit.
Why Is ROE Important For 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.
A Side By Side comparison of Howden Joinery Group's Earnings Growth And 20% ROE
To begin with, Howden Joinery Group seems to have a respectable ROE. Especially when compared to the industry average of 14% the company's ROE looks pretty impressive. Needless to say, we are quite surprised to see that Howden Joinery Group's net income shrunk at a rate of 2.2% over the past five years. Therefore, there might be some other aspects that could explain this. These include low earnings retention or poor allocation of capital.
That being said, we compared Howden Joinery Group's 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 7.3% 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. 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 Howden Joinery Group is trading on a high P/E or a low P/E, relative to its industry.
Is Howden Joinery Group Efficiently Re-investing Its Profits?
In spite of a normal three-year median payout ratio of 37% (that is, a retention ratio of 63%), the fact that Howden Joinery Group's earnings have shrunk is quite puzzling. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.
Moreover, Howden Joinery Group has been paying dividends for nine years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer consistent dividends even though earnings have been shrinking. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 37%. However, Howden Joinery Group's ROE is predicted to rise to 27% despite there being no anticipated change in its payout ratio.
Summary
In total, it does look like Howden Joinery Group has some positive aspects to its business. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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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