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With its stock down 19% over the past three months, it is easy to disregard Michael Hill International (ASX:MHJ). However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Specifically, we decided to study Michael Hill International's ROE in this article.
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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
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 Michael Hill International is:
23% = AU$45m ÷ AU$198m (Based on the trailing twelve months to December 2021).
The 'return' is the yearly profit. That means that for every A$1 worth of shareholders' equity, the company generated A$0.23 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. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.
Michael Hill International's Earnings Growth And 23% ROE
Firstly, we acknowledge that Michael Hill International has a significantly high ROE. Even when compared to the industry average of 21% the company's ROE is pretty decent. However, When you compare Michael Hill International's high ROE with its rather flat earnings, you are left wondering, what's causing the growth to lag? We reckon that there could be some other factors at play here that's limiting the company's growth. For example, it could be that the company has a high payout ratio or the the business has allocated capital poorly, for instance.
As a next step, we compared Michael Hill International's net income growth with the industry and discovered that the industry saw an average growth of 18% in the same period.
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. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Michael Hill International is trading on a high P/E or a low P/E, relative to its industry.
Is Michael Hill International Making Efficient Use Of Its Profits?
Michael Hill International has a high three-year median payout ratio of 58% (or a retention ratio of 42%), meaning that the company is paying most of its profits as dividends to its shareholders. This does go some way in explaining why there's been no growth in its earnings.
In addition, Michael Hill International has been paying dividends over a period of six 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 is expected to keep paying out approximately 57% of its profits over the next three years. As a result, Michael Hill International's ROE is not expected to change by much either, which we inferred from the analyst estimate of 25% for future ROE.
In total, it does look like Michael Hill International has some positive aspects to its business. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE. Bear in mind, the company reinvests a small portion of its profits, which means that investors aren't reaping the benefits of the high rate of return. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. 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.