CNA Financial’s’s (NYSE:CNA) stock is up by a considerable 20% over the past three months. Given that stock prices are usually aligned with a company’s financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. Particularly, we will be paying attention to CNA Financial’s 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.
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 CNA Financial is:
5.8% = US$597m ÷ US$10b (Based on the trailing twelve months to March 2020).
The ‘return’ is the profit over the last twelve months. That means that for every $1 worth of shareholders’ equity, the company generated $0.06 in profit.
What Is The Relationship Between ROE And Earnings Growth?
So far, we’ve learnt that ROE is a measure of a company’s profitability. Based on how much of its profits the company chooses to reinvest or “retain”, we are then able to evaluate a company’s future ability to generate profits. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don’t have the same features.
CNA Financial’s Earnings Growth And 5.8% ROE
At first glance, CNA Financial’s ROE doesn’t look very promising. A quick further study shows that the company’s ROE doesn’t compare favorably to the industry average of 8.9% either. Although, we can see that CNA Financial saw a modest net income growth of 5.4% over the past five years. So, there might be other aspects that are positively influencing the company’s earnings growth. For instance, the company has a low payout ratio or is being managed efficiently.
Next, on comparing with the industry net income growth, we found that CNA Financial’s reported growth was lower than the industry growth of 7.8% in the same period, which is not something we like to see.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. Is CNA fairly valued? This infographic on the company’s intrinsic value has everything you need to know.
Is CNA Financial Efficiently Re-investing Its Profits?
CNA Financial has a three-year median payout ratio of 35%, which implies that it retains the remaining 65% of its profits. This suggests that its dividend is well covered, and given the decent growth seen by the company, it looks like management is reinvesting its earnings efficiently.
Besides, CNA Financial has been paying dividends over a period of nine years. This shows that the company is committed to sharing profits with its shareholders.
On the whole, we do feel that CNA Financial has some positive attributes. Specifically, its fairly high earnings growth number, which no doubt was backed by the company’s high earnings retention. Still, the low ROE means that all that reinvestment is not reaping a lot of benefit to the investors. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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.
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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. Thank you for reading.