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Does Hewlett Packard Enterprise Company's (NYSE:HPE) Weak Fundamentals Mean That The Market Could Correct Its Share Price? – Simply Wall St


Hewlett Packard Enterprise (NYSE:HPE) has had a great run on the share market with its stock up by a significant 19% over the last month. However, in this article, we decided to focus on its weak fundamentals, as long-term financial performance of a business is what ultimatley dictates market outcomes. Specifically, we decided to study Hewlett Packard Enterprise’s ROE in this article.

Return on equity or ROE is a key measure used to assess how efficiently a company’s management is utilizing the company’s capital. In simpler terms, it measures the profitability of a company in relation to shareholder’s equity.

View our latest analysis for Hewlett Packard Enterprise

How Is ROE Calculated?

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 Hewlett Packard Enterprise is:

6.0% = US$1.0b ÷ US$17b (Based on the trailing twelve months to July 2021).

The ‘return’ is the yearly profit. One way to conceptualize this is that for each $1 of shareholders’ capital it has, the company made $0.06 in profit.

Why Is ROE Important For Earnings Growth?

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

A Side By Side comparison of Hewlett Packard Enterprise’s Earnings Growth And 6.0% ROE

When you first look at it, Hewlett Packard Enterprise’s ROE doesn’t look that attractive. A quick further study shows that the company’s ROE doesn’t compare favorably to the industry average of 18% either. Therefore, it might not be wrong to say that the five year net income decline of 46% seen by Hewlett Packard Enterprise was probably the result of it having a lower ROE. However, there could also be other factors causing the earnings to decline. Such as – low earnings retention or poor allocation of capital.

So, as a next step, we compared Hewlett Packard Enterprise’s 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 17% in the same period.

past-earnings-growth
NYSE:HPE Past Earnings Growth October 22nd 2021

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. Doing so will help them establish if the stock’s future looks promising or ominous. Has the market priced in the future outlook for HPE? You can find out in our latest intrinsic value infographic research report.

Is Hewlett Packard Enterprise Efficiently Re-investing Its Profits?

With a high three-year median payout ratio of 50% (implying that 50% of the profits are retained), most of Hewlett Packard Enterprise’s profits are being paid to shareholders, which explains the company’s shrinking earnings. With only a little being reinvested into the business, earnings growth would obviously be low or non-existent. You can see the 3 risks we have identified for Hewlett Packard Enterprise by visiting our risks dashboard for free on our platform here.

In addition, Hewlett Packard Enterprise has been paying dividends over a period of six years suggesting that keeping up dividend payments is preferred by the management even though earnings have been in decline. Upon studying the latest analysts’ consensus data, we found that the company’s future payout ratio is expected to drop to 26% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company’s ROE to 15%, over the same period.

Summary

On the whole, Hewlett Packard Enterprise’s performance is quite a big let-down. As a result of its low ROE and lack of much reinvestment into the business, the company has seen a disappointing earnings growth rate. Having said that, looking at current analyst estimates, we found that the company’s earnings growth rate is expected to see a huge improvement. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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.

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



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