It is hard to get excited after looking at H2O Innovation's (TSE:HEO) recent performance, when its stock has declined 12% over the past three months. However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Particularly, we will be paying attention to H2O Innovation'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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
How Do You Calculate Return On Equity?
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 H2O Innovation is:
2.8% = CA$2.5m ÷ CA$90m (Based on the trailing twelve months to March 2022).
The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every CA$1 worth of equity, the company was able to earn CA$0.03 in profit.
What Has ROE Got To Do With 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 H2O Innovation's Earnings Growth And 2.8% ROE
It is quite clear that H2O Innovation's ROE is rather low. Even when compared to the industry average of 6.2%, the ROE figure is pretty disappointing. Despite this, surprisingly, H2O Innovation saw an exceptional 48% net income growth over the past five years. We believe that there might be other aspects that are positively influencing the company's earnings growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.
As a next step, we compared H2O Innovation's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 13%.
Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. What is HEO worth today? The intrinsic value infographic in our free research report helps visualize whether HEO is currently mispriced by the market.
Is H2O Innovation Using Its Retained Earnings Effectively?
H2O Innovation doesn't pay any dividend to its shareholders, meaning that the company has been reinvesting all of its profits into the business. This is likely what's driving the high earnings growth number discussed above.
Overall, we feel that H2O Innovation certainly does have some positive factors to consider. With a high rate of reinvestment, albeit at a low ROE, the company has managed to see a considerable growth in its earnings. The latest industry analyst forecasts show that the company is expected to maintain its current growth rate. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.
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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.
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