Most readers would already know that Haleon's (LON:HLN) stock increased by 3.9% over the past week. However, we decided to study the company's mixed-bag of fundamentals to assess what this could mean for future share prices, as stock prices tend to be aligned with a company's long-term financial performance. Specifically, we decided to study Haleon's ROE in this article.

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 Haleon

How Do You Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Haleon is:

7.5% = UK£1.3b ÷ UK£17b (Based on the trailing twelve months to September 2024).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every £1 worth of equity, the company was able to earn £0.08 in profit.

What Has ROE Got To Do With 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.

Haleon's Earnings Growth And 7.5% ROE

At first glance, Haleon's ROE doesn't look very promising. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 32%. Accordingly, Haleon's low net income growth of 2.7% over the past five years can possibly be explained by the low ROE amongst other factors.

As a next step, we compared Haleon's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 3.8% in the same period.

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. 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 HLN? You can find out in our latest intrinsic value infographic research report.

Is Haleon Efficiently Re-investing Its Profits?

Despite having a normal three-year median payout ratio of 47% (or a retention ratio of 53% over the past three years, Haleon has seen very little growth in earnings as we saw above. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

Additionally, Haleon started paying a dividend only recently. So it looks like the management must have perceived that shareholders favor dividends over earnings growth. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 37% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 9.5%, over the same period.

Summary

Overall, we have mixed feelings about Haleon. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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

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.