Is Weakness In James Halstead plc (LON:JHD) Stock A Sign That The Market Could be Wrong Given Its Strong Financial Prospects?

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Simply Wall St

Mon, May 9, 2022, 2:18 AM 4 min read

It is hard to get excited after looking at James Halstead's (LON:JHD) recent performance, when its stock has declined 19% over the past three months. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Particularly, we will be paying attention to James Halstead's ROE today.

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for James Halstead

How To 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 James Halstead is:

25% = UK£39m ÷ UK£156m (Based on the trailing twelve months to December 2021).

The 'return' refers to a company's earnings over the last year. That means that for every £1 worth of shareholders' equity, the company generated £0.25 in profit.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.

A Side By Side comparison of James Halstead's Earnings Growth And 25% ROE

Firstly, we acknowledge that James Halstead has a significantly high ROE. Second, a comparison with the average ROE reported by the industry of 15% also doesn't go unnoticed by us. However, we are curious as to how the high returns still resulted in a flat growth for James Halstead in the past five years. We reckon that there could be some other factors at play here that's limiting the company's growth. These include low earnings retention or poor allocation of capital

Next, on comparing with the industry net income growth, we found that the growth figure reported by James Halstead compares quite favourably to the industry average, which shows a decline of 6.6% in the same period.

past-earnings-growth — AIM:JHD Past Earnings Growth May 9th 2022

Earnings growth is a huge factor in stock valuation. 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. Has the market priced in the future outlook for JHD? You can find out in our latest intrinsic value infographic research report.

Is James Halstead Using Its Retained Earnings Effectively?

With a high three-year median payout ratio of 80% (implying that the company keeps only 20% of its income) of its business to reinvest into its business), most of James Halstead's profits are being paid to shareholders, which explains the absence of growth in earnings.

Additionally, James Halstead has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 85% of its profits over the next three years. Accordingly, forecasts suggest that James Halstead's future ROE will be 25% which is again, similar to the current ROE.

Summary

In total, we are pretty happy with James Halstead's performance. We are particularly impressed by the considerable earnings growth posted by the company, which was likely backed by its high ROE. While the company is paying out most of its earnings as dividends, it has been able to grow its earnings in spite of it, so that's probably a good sign. Up till now, we've only made a short study of the company's growth data. So it may be worth checking this free detailed graph of James Halstead's past earnings, as well as revenue and cash flows to get a deeper insight into the company's performance.

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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.