Hotel Property Investments' (ASX:HPI) stock up by 3.5% over the past three months. However, the company's financials look a bit inconsistent and market outcomes are ultimately driven by long-term fundamentals, meaning that the stock could head in either direction. Particularly, we will be paying attention to Hotel Property Investments' ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Hotel Property Investments

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 Hotel Property Investments is:

9.5% = AU$50m ÷ AU$534m (Based on the trailing twelve months to December 2020).

The 'return' is the profit over the last twelve months. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.09.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.

A Side By Side comparison of Hotel Property Investments' Earnings Growth And 9.5% ROE

At first glance, Hotel Property Investments' ROE doesn't look very promising. However, the fact that the its ROE is quite higher to the industry average of 6.7% doesn't go unnoticed by us. But seeing Hotel Property Investments' five year net income decline of 12% over the past five years, we might rethink that. Remember, the company's ROE is a bit low to begin with, just that it is higher than the industry average. So that could be one of the factors that are causing earnings growth to shrink.

So, as a next step, we compared Hotel Property Investments' 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 4.5% in the same period.

Earnings growth is an important metric to consider when valuing a stock. 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. Has the market priced in the future outlook for HPI? You can find out in our latest intrinsic value infographic research report.

Is Hotel Property Investments Making Efficient Use Of Its Profits?

Hotel Property Investments has a very high three-year median payout ratio of 52%, implying that it retains only 48% of its profits. However, it's not unusual to see a REIT with such a high payout ratio mainly due to statutory requirements. So this probably explains the company's shrinking earnings.

In addition, Hotel Property Investments has been paying dividends over a period of seven 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 rise to 98% over the next three years. Accordingly, the expected increase in the payout ratio explains the expected decline in the company's ROE to 6.7%, over the same period.

Conclusion

Overall, we have mixed feelings about Hotel Property Investments. Primarily, we are disappointed to see a lack of growth in earnings even in spite of a moderate ROE. Bear in mind, the company reinvests a small portion of its profits, which explains the lack of growth. That being so, the latest industry analyst forecasts show that analysts are forecasting a slight improvement in the company's future earnings growth. This could offer some relief to the company's existing shareholders. 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.

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.

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