Harvey Norman Holdings (ASX:HVN) has had a rough week with its share price down 12%. 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. Specifically, we decided to study Harvey Norman Holdings'  ROE in this article.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

See our latest analysis for Harvey Norman Holdings

How Do You 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 Harvey Norman Holdings is:

12% = AU$547m ÷ AU$4.5b (Based on the trailing twelve months to June 2023).

The 'return' refers to a company's earnings 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 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. 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 begin with, Harvey Norman Holdings seems to have a respectable ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 12%. Consequently, this likely laid the ground for the decent growth of 15% seen over the past five years by Harvey Norman Holdings.



Next, on comparing Harvey Norman Holdings' net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 15% over the last few years.

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. What is HVN worth today? The  intrinsic value infographic in our free research report  helps visualize whether HVN is currently mispriced by the market.

Is Harvey Norman Holdings Making Efficient Use Of Its Profits?

Harvey Norman Holdings has a significant three-year median payout ratio of 54%, meaning that it is left with only 46% to reinvest into its business. This implies that the company has been able to achieve decent earnings growth despite returning most of its profits to shareholders.

Besides, Harvey Norman Holdings has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 74% over the next three years. Therefore, the expected rise in the payout ratio explains why the company's ROE is expected to decline to 9.5% over the same period.

Summary

On the whole, we feel that Harvey Norman Holdings' performance has been quite good. Especially the high ROE, Which has contributed to the impressive growth seen in earnings. Despite the company reinvesting only a small portion of its profits, it still has managed to grow its earnings so that is appreciable. Having said that, on studying current analyst estimates, we were concerned to see that while the company has grown its earnings in the past, analysts expect its earnings to shrink in the future. To know more about the company's future earnings growth forecasts take a look at this freereport 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.