Insurance Australia Group's (ASX:IAG) stock is up by a considerable 18% over the past three months. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. In this article, we decided to focus on Insurance Australia Group's ROE.
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
View our latest analysis for Insurance Australia Group
How To 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 Insurance Australia Group is:
15% = AU$1.0b ÷ AU$7.1b (Based on the trailing twelve months to June 2024).
The 'return' is the profit over the last twelve months. Another way to think of that is that for every A$1 worth of equity, the company was able to earn A$0.15 in profit.
Why Is ROE Important For Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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 Insurance Australia Group's Earnings Growth And 15% ROE
To start with, Insurance Australia Group's ROE looks acceptable. Especially when compared to the industry average of 12% the company's ROE looks pretty impressive. This probably laid the ground for Insurance Australia Group's moderate 15% net income growth seen over the past five years.
We then performed a comparison between Insurance Australia Group's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 17% in the same 5-year period.
Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. What is IAG worth today? The intrinsic value infographic in our free research report helps visualize whether IAG is currently mispriced by the market.
Is Insurance Australia Group Using Its Retained Earnings Effectively?
The high three-year median payout ratio of 54% (or a retention ratio of 46%) for Insurance Australia Group suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.
Moreover, Insurance Australia Group is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 75% over the next three years. Regardless, the ROE is not expected to change much for the company despite the higher expected payout ratio.
Conclusion
Overall, we are quite pleased with Insurance Australia Group's performance. In particular, its high ROE is quite noteworthy and also the probable explanation behind its considerable earnings growth. Yet, the company is retaining a small portion of its profits. Which means that the company has been able to grow its earnings in spite of it, so that's not too bad. 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. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.
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