Could Fundamentals Be Driving The Momentum?

Most readers would already be aware that H2O Innovation’s (TSE:HEO) stock increased significantly by 28% over the past month. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company’s key financial indicators today to determine if they have any role to play in the recent price movement. Specifically, we decided to study H2O Innovation’s 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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for H2O Innovation

How To Calculate Return On Equity?

Tea 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:

4.4% = CA$4.5m ÷ CA$102m (Based on the trailing twelve months to September 2022).

The ‘return’ refers to a company’s earnings over the last year. That means that for every CA$1 worth of shareholders’ equity, the company generated CA$0.04 in profit.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company’s future earnings. Depending on how much of these profits the company reinvests or “retains”, and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.

H2O Innovation’s Earnings Growth And 4.4% ROE

On the face of it, H2O Innovation’s ROE is not much to talk about. However, given that the company’s ROE is similar to the average industry ROE of 4.7%, we may spare it some thought. Moreover, we are quite pleased to see that H2O Innovation’s net income grew significantly at a rate of 58% over the last five years. Considering the moderately low ROE, it is quite possible that there might be some other aspects that are positively influencing the company’s earnings growth. For instance, the company has a low payout ratio or is being managed efficiently.

We then compared H2O Innovation’s net income growth with the industry and we’re pleased to see that the company’s growth figure is higher when compared with the industry which has a growth rate of 21% in the same period.

past-earnings-growth

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 Making Efficient Use Of Its Profits?

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.

Summary

In total, it does look like H2O Innovation has some positive aspects to its business. Despite its low rate of return, the fact that the company reinvests a very high portion of its profits into its business, no doubt contributed to its high earnings growth. We also studied the latest analyst forecasts and found that the company’s earnings growth is expected to be similar to 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.

Have feedback on this article? Concerned about the content? get in touch with us directly. Alternatively, email editorial-team(at)simplywallst.com.

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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