With its stock down 5.9% over the past week, it is easy to disregard Hour Glass (SGX:AGS). However, stock prices are usually driven by a company's financial performance over the long term, which in this case looks quite promising. In this article, we decided to focus on Hour Glass' ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors' money. Put another way, it reveals the company's success at turning shareholder investments into profits.

View our latest analysis for Hour Glass

How Is ROE Calculated?

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 Hour Glass is:

20% = S$157m ÷ S$768m (Based on the trailing twelve months to March 2022).

The 'return' refers to a company's earnings over the last year. So, this means that for every SGD1 of its shareholder's investments, the company generates a profit of SGD0.20.

Why Is ROE Important For Earnings Growth?

So far, we've learned 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. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

Hour Glass' Earnings Growth And 20% ROE

To start with, Hour Glass' ROE looks acceptable. Further, the company's ROE compares quite favorably to the industry average of 14%. This certainly adds some context to Hour Glass' exceptional 21% net income growth seen over the past five years. We believe that there might also be other aspects that are positively influencing the company's earnings growth. Such as - high earnings retention or an efficient management in place.

Next, on comparing with the industry net income growth, we found that Hour Glass' growth is quite high when compared to the industry average growth of 10% in the same period, which is great to see.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It's important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Hour Glass''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Hour Glass Making Efficient Use Of Its Profits?

The three-year median payout ratio for Hour Glass is 36%, which is moderately low. The company is retaining the remaining 64%. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like Hour Glass is reinvesting its earnings efficiently.

Besides, Hour Glass has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 33%. Accordingly, forecasts suggest that Hour Glass' future ROE will be 18% which is again, similar to the current ROE.

Summary

On the whole, we feel that Hour Glass' performance has been quite good. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. 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.