Shares of ProAssurance (NYSE:PRA) are up 10% in the past month. As most know, fundamentals are what generally guide market price movements over the long term, so we decided to take a look at key financial indicators in business today to see if they have a role to play. play in the recent price movement. In particular, we’ll be paying attention to ProAssurance’s ROE today.
Return on equity or ROE is an important factor for a shareholder to consider as it tells them how much of their capital is being reinvested. In other words, it reveals the company’s success in turning shareholders’ investments into profits.
Check out our latest analysis for ProAssurance
How do you 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, the ROE for ProAssurance is:
10% = $144 million ÷ $1.4 billion (based on trailing 12 months to December 2021).
The “return” is the annual profit. Another way to think about this is that for every dollar of equity, the company was able to make a profit of $0.10.
What does ROE have to do with earnings growth?
We have already established that ROE serves as an effective profit-generating indicator for a company’s future earnings. Based on the share of its profits that the company chooses to reinvest or “keep”, we are then able to assess a company’s future ability to generate profits. Generally speaking, all things being equal, companies with high return on equity and earnings retention have a higher growth rate than companies that do not share these attributes.
Profit growth and 10% ROE from ProAssurance
For starters, ProAssurance’s ROE seems acceptable. Even compared to the industry average of 11%, the company’s ROE looks pretty decent. For this reason, ProAssurance’s 43% drop in net income over five years raises the question of why decent ROE has not translated into growth. So there could be other aspects that could explain this. These include poor revenue retention or poor capital allocation.
That being said, we benchmarked ProAssurance’s performance against the industry and were concerned when we found that while the company had reduced profits, the industry had increased profits at a rate of 14% over the course of the same period.
Earnings growth is an important metric to consider when evaluating a stock. 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. Is ProAssurance valued at its fair value compared to other companies? These 3 assessment metrics might help you decide.
Does ProAssurance use its profits efficiently?
When we piece together ProAssurance’s low three-year median payout ratio of 7.5% (where it retains 93% of its earnings), calculated for the last three-year period, we are intrigued by the lack of growth. The low payout should mean that the company keeps most of its profits and therefore should see some growth. It seems that there could be other reasons for the lack in this regard. For example, the business might be in decline.
Additionally, ProAssurance has paid dividends over a period of at least ten years, which means the company’s management is committed to paying dividends even if it means little or no earnings growth. Looking at current analyst consensus data, we can see that the company’s future payout ratio is expected to reach 38% over the next three years. Thus, the expected increase in the payout rate explains the expected drop in the company’s ROE to 3.9%, over the same period.
All in all, it seems that ProAssurance has positive aspects for its activity. However, we are disappointed to see a lack of earnings growth, even despite a high ROE and high reinvestment rate. We believe there could be external factors that could negatively impact the business. Additionally, by studying the latest analyst forecasts, we have seen that the company’s earnings are expected to continue to contract. For more on the company’s future earnings growth forecast, check out this free analyst forecast report for the company to learn more.
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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.