Harvey Norman Holdings Limited's (ASX:HVN) Stock Financial Prospects Look Bleak: Should Shareholders Be Prepared For A Share Price Correction?

editorial-team@simplywallst.com (Simply Wall St)

Mon, Sep 23, 2024, 2:19 PM 4 min read

Harvey Norman Holdings' (ASX:HVN) stock is up by 5.9% over the past three months. Given that the markets usually pay for the long-term financial health of a company, we wonder if the current momentum in the share price will keep up, given that the company's financials don't look very promising. Specifically, we decided to study Harvey Norman Holdings' ROE in this article.

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.

View our latest analysis for Harvey Norman Holdings

How Is ROE Calculated?

The formula for return on equity is:

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

So, based on the above formula, the ROE for Harvey Norman Holdings is:

7.9% = AU$358m ÷ AU$4.5b (Based on the trailing twelve months to June 2024).

The 'return' is the profit over the last twelve months. That means that for every A$1 worth of shareholders' equity, the company generated A$0.08 in profit.

What Has ROE Got To Do With 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 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.

Harvey Norman Holdings' Earnings Growth And 7.9% ROE

At first glance, Harvey Norman Holdings' ROE doesn't look very promising. Yet, a closer study shows that the company's ROE is similar to the industry average of 7.9%. Still, Harvey Norman Holdings has seen a flat net income growth over the past five years. Remember, the company's ROE is not particularly great to begin with. Hence, this provides some context to the flat earnings growth seen by the company.

Next, on comparing with the industry net income growth, we found that the industry grew its earnings by 7.6% over the last few years.

past-earnings-growth — ASX:HVN Past Earnings Growth September 23rd 2024

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. This then helps them determine if the stock is placed for a bright or bleak future. Is HVN fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Harvey Norman Holdings Using Its Retained Earnings Effectively?

With a high three-year median payout ratio of 56% (implying that the company keeps only 44% of its income) of its business to reinvest into its business), most of Harvey Norman Holdings' profits are being paid to shareholders, which explains the absence of growth in earnings.

In addition, Harvey Norman Holdings 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. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 75% over the next three years. However, Harvey Norman Holdings' future ROE is expected to rise to 10% despite the expected increase in the company's payout ratio. We infer that there could be other factors that could be driving the anticipated growth in the company's ROE.

Summary

On the whole, Harvey Norman Holdings' performance is quite a big let-down. The company has seen a lack of earnings growth as a result of retaining very little profits and whatever little it does retain, is being reinvested at a very low 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.