In This Article:
With its stock down 7.7% over the past month, it is easy to disregard Halma (LON:HLMA). But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Particularly, we will be paying attention to Halma's ROE today.
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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.
View our latest analysis for Halma
How To Calculate Return On Equity?
ROE 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 Halma is:
14% = UK£223m ÷ UK£1.6b (Based on the trailing twelve months to September 2022).
The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.14 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 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.
Halma's Earnings Growth And 14% ROE
To start with, Halma's ROE looks acceptable. Further, the company's ROE compares quite favorably to the industry average of 8.3%. This certainly adds some context to Halma's decent 11% net income growth seen over the past five years.
When you consider the fact that the industry earnings have shrunk at a rate of 1.6% in the same period, the company's net income growth is pretty remarkable.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. If you're wondering about Halma's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Halma Making Efficient Use Of Its Profits?
Halma has a three-year median payout ratio of 33%, which implies that it retains the remaining 67% of its profits. This suggests that its dividend is well covered, and given the decent growth seen by the company, it looks like management is reinvesting its earnings efficiently.