Could The Market Be Wrong About Harvey Norman Holdings Limited (ASX:HVN) Given Its Attractive Financial Prospects?

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With its stock down 38% over the past three months, it is easy to disregard Harvey Norman Holdings (ASX:HVN). 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. In this article, we decided to focus on Harvey Norman Holdings’ ROE.

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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company’s shareholders.

View our latest analysis for Harvey Norman Holdings

How Is ROE Calculated?

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 Harvey Norman Holdings is:

12% = AU$400m ÷ AU$3.3b (Based on the trailing twelve months to December 2019).

The ‘return’ is the income the business earned over the last year. One way to conceptualize this is that for each A$1 of shareholders’ capital it has, the company made A$0.12 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we’ve learnt that ROE is a measure of a company’s profitability. 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

Harvey Norman Holdings’ Earnings Growth And 12% ROE

To start with, Harvey Norman Holdings’ ROE looks acceptable. Especially when compared to the industry average of 7.5% the company’s ROE looks pretty impressive. This certainly adds some context to Harvey Norman Holdings’ decent 7.7% net income growth seen over the past five years.

Next, on comparing with the industry net income growth, we found that Harvey Norman Holdings’ growth is quite high when compared to the industry average growth of 2.4% in the same period, which is great to see.

ASX:HVN Past Earnings Growth May 23rd 2020

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock’s future looks promising or ominous. 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?

The high three-year median payout ratio of 79% (or a retention ratio of 21%) for Harvey Norman Holdings suggests that the company’s growth wasn’t really hampered despite it returning most of its income to its shareholders.

Upon studying the latest analysts’ consensus data, we found that the company is expected to keep paying out approximately 79% of its profits over the next three years. However, Harvey Norman Holdings’ future ROE is expected to decline to 9.5% despite there being not much change anticipated in the company’s payout ratio.

Summary

In total, we are pretty happy with Harvey Norman Holdings’ performance. In particular, its high ROE is quite noteworthy and also the probable explanation behind its considerable earnings growth. Yet, the company is retaining a small portion of its profits. Which means that the company has been able to grow its earnings in spite of it, so that’s not too bad. With that said, the latest industry analyst forecasts reveal that the company’s earnings growth is expected to slow down. 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. 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. Thank you for reading.