Most readers would already be aware that HPP Holdings Berhad's (KLSE:HPPHB) stock increased significantly by 18% over the past three months. However, we decided to pay close attention to its weak financials as we are doubtful that the current momentum will keep up, given the scenario. Particularly, we will be paying attention to HPP Holdings Berhad's ROE today.
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. 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 HPP Holdings Berhad
How Is ROE Calculated?
Return on equity 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 HPP Holdings Berhad is:
7.5% = RM9.3m ÷ RM123m (Based on the trailing twelve months to May 2023).
The 'return' is the amount earned after tax over the last twelve months. That means that for every MYR1 worth of shareholders' equity, the company generated MYR0.08 in profit.
What Has ROE Got To Do With Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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 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.
HPP Holdings Berhad's Earnings Growth And 7.5% ROE
On the face of it, HPP Holdings Berhad's ROE is not much to talk about. Next, when compared to the average industry ROE of 11%, the company's ROE leaves us feeling even less enthusiastic. Therefore, it might not be wrong to say that the five year net income decline of 7.4% seen by HPP Holdings Berhad was probably the result of it having a lower ROE. However, there could also be other factors causing the earnings to decline. Such as - low earnings retention or poor allocation of capital.
That being said, we compared HPP Holdings Berhad'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 15% in the same 5-year period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). 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 HPPHB? You can find out in our latest intrinsic value infographic research report.