Highway Holdings Limited's (NASDAQ:HIHO) On An Uptrend But Financial Prospects Look Pretty Weak: Is The Stock Overpriced?

Highway Holdings' (NASDAQ:HIHO) stock is up by a considerable 62% over the past three months. We, however wanted to have a closer look at its key financial indicators as the markets usually pay for long-term fundamentals, and in this case, they don't look very promising. In this article, we decided to focus on Highway Holdings' ROE.

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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

View our latest analysis for Highway Holdings

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 Highway Holdings is:

8.6% = US$905k ÷ US$11m (Based on the trailing twelve months to September 2020).

The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.09 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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.

Highway Holdings' Earnings Growth And 8.6% ROE

On the face of it, Highway Holdings' ROE is not much to talk about. Next, when compared to the average industry ROE of 11%, the company's ROE leaves us feeling even less enthusiastic. For this reason, Highway Holdings' five year net income decline of 26% is not surprising given its lower ROE. However, there could also be other factors causing the earnings to decline. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

So, as a next step, we compared Highway Holdings' performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 10.0% in the same period.

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. This then helps them determine if the stock is placed for a bright or bleak future. Has the market priced in the future outlook for HIHO? You can find out in our latest intrinsic value infographic research report

Is Highway Holdings Making Efficient Use Of Its Profits?

Highway Holdings' declining earnings is not surprising given how the company is spending most of its profits in paying dividends, judging by its three-year median payout ratio of 78% (or a retention ratio of 22%). With only very little left to reinvest into the business, growth in earnings is far from likely. Our risks dashboard should have the 5 risks we have identified for Highway Holdings.

Additionally, Highway Holdings has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth.

Conclusion

In total, we would have a hard think before deciding on any investment action concerning Highway Holdings. The company has seen a lack of earnings growth as a result of retaining very little profits and whatever little it does retain, is being reinvested at a very low rate of return. So far, we've only made a quick discussion around the company's earnings growth. To gain further insights into Highway Holdings' past profit growth, check out this visualization of past earnings, revenue and cash flows.

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.

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