M. Hamburger SA (WSE:MRH) stock has shown weakness lately, but the financial outlook looks decent: is the market wrong?

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Mr. Hamburger (WSE:MRH) had a tough month with its share price down 23%. But if you pay close attention, you might find that its leading financial indicators look pretty decent, which could mean the stock could potentially rise in the long run as markets generally reward more resilient long-term fundamentals. Specifically, we decided to study Mr. Hamburger’s ROE in this article.

Return on Equity or ROE is a test of how effectively a company increases its value and manages investors’ money. In simpler terms, it measures a company’s profitability relative to equity.

See our latest review for Mr Hamburger

How to calculate return on equity?

Return on equity can be calculated using the formula:

Return on equity = Net income (from continuing operations) ÷ Equity

So, based on the above formula, Mr. Hamburger’s ROE is:

20% = 168,000 zł ÷ 850,000 zł (based on the last twelve months until December 2021).

The “yield” is the amount earned after tax over the last twelve months. This means that for every 1 PLN worth of equity, the company has generated 0.20 PLN profit.

What is the relationship between ROE and earnings growth?

So far, we have learned that ROE measures how efficiently a company generates its profits. Depending on how much of those earnings the company reinvests or “keeps”, and how efficiently it does so, we are then able to gauge a company’s earnings growth potential. Assuming everything else remains unchanged, the higher the ROE and earnings retention, the higher a company’s growth rate compared to companies that don’t necessarily exhibit these characteristics.

Growth in Mr. Hamburger’s profits and 20% ROE

At first glance, Mr. Hamburger appears to have a decent ROE. Especially when compared to the industry average of 10%, the company’s ROE looks quite impressive. For this reason, Mr. Hamburger’s 29% drop in net income over five years raises the question of why high ROE has not translated into earnings growth. We feel there could be other factors at play here that are preventing the company from growing. For example, the company pays a large portion of its profits in the form of dividends or faces competitive pressures.

We then benchmarked Mr. Hamburger’s performance against the industry and found that the company cut profits at a slower rate than the industry’s profits, which saw their profits decline by 38% over the course of the same period. This relieves the shareholders

WSE: MRH Past Earnings Growth March 24, 2022

Earnings growth is an important factor in stock valuation. What investors then need to determine is whether the expected earnings growth, or lack thereof, is already priced into the stock price. This then helps them determine if the stock is positioned for a bright or bleak future. A good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings outlook. Thus, you might want to check whether Mr. Hamburger is trading on a high P/E or a low P/E, relative to his industry.

Does Mr. Hamburger effectively reinvest his profits?

Mr. Hamburger pays no dividends, which means the company keeps all of its profits, which makes us wonder why it keeps its profits if it can’t use them to grow its business. So there could be other explanations for this. For example, the company’s business may deteriorate.

Conclusion

Overall, we believe that Mr. Hamburger has positive qualities. However, given the high ROE and strong earnings retention, we would expect the company to post strong earnings growth, but that is not the case here. This suggests that there might be an external threat to the business, which is hampering its growth. While we wouldn’t completely dismiss the business, what we would do is try to figure out how risky the business is to make a more informed decision about the business. You can see the 4 risks we have identified for Mr Hamburger by visiting our risk dashboard for free on our platform here.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.

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