Hong Leong Industries Berhad's (KLSE:HLIND) stock was mostly flat over the past week. However, the company's key financials probably have more to say so you may want to give the company a closer look given that stock prices usually follow the long-term financial performance of a business. In this article, we decided to focus on Hong Leong Industries Berhad'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.

View our latest analysis for Hong Leong Industries Berhad

How Do You Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Hong Leong Industries Berhad is:

18% = RM406m ÷ RM2.3b (Based on the trailing twelve months to September 2023).

The 'return' is the yearly profit. So, this means that for every MYR1 of its shareholder's investments, the company generates a profit of MYR0.18.

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. 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.

A Side By Side comparison of Hong Leong Industries Berhad's Earnings Growth And 18% ROE

To begin with, Hong Leong Industries Berhad seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 10%. Needless to say, we are quite surprised to see that Hong Leong Industries Berhad's net income shrunk at a rate of 3.9% over the past five years. Based on this, we feel that there might be other reasons which haven't been discussed so far in this article that could be hampering the company's growth. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.

Furthermore, even when compared to the industry, which has been shrinking its earnings at a rate of 0.2% over the last few years, we found that Hong Leong Industries Berhad'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 a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. Is Hong Leong Industries Berhad fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Hong Leong Industries Berhad Using Its Retained Earnings Effectively?

Hong Leong Industries Berhad has a high three-year median payout ratio of 70% (that is, it is retaining 30% of its profits). This suggests that the company is paying most of its profits as dividends to its shareholders. This goes some way in explaining why its earnings have been shrinking. With only very little left to reinvest into the business, growth in earnings is far from likely.

Moreover, Hong Leong Industries Berhad has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth.

Summary

On the whole, we do feel that Hong Leong Industries Berhad 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. 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.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.