Most readers would already be aware that Travelers Companies’ (NYSE:TRV) stock increased significantly by 15% over the past three months. But the company’s key financial indicators appear to be differing across the board and that makes us question whether or not the company’s current share price momentum can be maintained. In this article, we decided to focus on Travelers Companies’ ROE.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company’s shareholders.
How Is ROE Calculated?
ROE can be calculated by using the formula:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders’ Equity
So, based on the above formula, the ROE for Travelers Companies is:
6.8% = US$1.8b ÷ US$27b (Based on the trailing twelve months to June 2020).
The ‘return’ is the yearly profit. One way to conceptualize this is that for each $1 of shareholders’ capital it has, the company made $0.07 in profit.
What Has ROE Got To Do With Earnings Growth?
So far, we’ve learned 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. 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.
Travelers Companies’ Earnings Growth And 6.8% ROE
When you first look at it, Travelers Companies’ ROE doesn’t look that attractive. Next, when compared to the average industry ROE of 8.9%, the company’s ROE leaves us feeling even less enthusiastic. For this reason, Travelers Companies’ five year net income decline of 9.8% is not surprising given its lower ROE. We reckon that there could also be other factors at play here. For instance, the company has a very high payout ratio, or is faced with competitive pressures.
That being said, we compared Travelers Companies’ performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 7.3% in the same period.
Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is TRV fairly valued? This infographic on the company’s intrinsic value has everything you need to know.
Is Travelers Companies Using Its Retained Earnings Effectively?
In spite of a normal three-year median payout ratio of 33% (that is, a retention ratio of 67%), the fact that Travelers Companies’ earnings have shrunk is quite puzzling. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.
Moreover, Travelers Companies has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Based on the latest analysts’ estimates, we found that the company’s future payout ratio over the next three years is expected to hold steady at 34%. Regardless, the future ROE for Travelers Companies is predicted to rise to 9.7% despite there being not much change expected in its payout ratio.
On the whole, we feel that the performance shown by Travelers Companies can be open to many interpretations. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the earnings growth. Having said that, looking at current analyst estimates, we found that the company’s earnings growth rate is expected to see a huge improvement. 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.
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