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It is hard to get excited after looking at Hargreaves Services' (LON:HSP) recent performance, when its stock has declined 19% over the past three months. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. In this article, we decided to focus on Hargreaves Services' ROE.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
View our latest analysis for Hargreaves Services
How Do You Calculate Return On Equity?
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 Hargreaves Services is:
17% = UK£25m ÷ UK£149m (Based on the trailing twelve months to November 2021).
The 'return' is the income the business earned over the last year. That means that for every £1 worth of shareholders' equity, the company generated £0.17 in profit.
What Is The Relationship Between ROE And Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.
Hargreaves Services' Earnings Growth And 17% ROE
At first glance, Hargreaves Services seems to have a decent ROE. On comparing with the average industry ROE of 14% the company's ROE looks pretty remarkable. This probably laid the ground for Hargreaves Services' significant 55% net income growth seen over the past five years. We reckon that there could also be other factors at play here. For instance, the company has a low payout ratio or is being managed efficiently.
Given that the industry shrunk its earnings at a rate of 1.5% in the same period, the net income growth of the company is quite impressive.
Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Hargreaves Services''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.