Al Dhafra Insurance Company P.S.C.'s (ADX:DHAFRA) Stock's Been Going Strong: Could Weak Financials Mean The Market Will Correct Its Share Price?

Al Dhafra Insurance Company P.S.C's (ADX:DHAFRA) stock is up by a considerable 16% over the past week. We, however wanted to have a closer look at its key financial indicators as the markets usually pay for long-term fundamentals, and in this case, they don't look very promising. In this article, we decided to focus on Al Dhafra Insurance Company P.S.C'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. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for Al Dhafra Insurance Company P.S.C

How To Calculate Return On Equity?

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 Al Dhafra Insurance Company P.S.C is:

8.9% = د.إ41m ÷ د.إ464m (Based on the trailing twelve months to December 2023).

The 'return' is the profit over the last twelve months. That means that for every AED1 worth of shareholders' equity, the company generated AED0.09 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. 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. 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.

Al Dhafra Insurance Company P.S.C's Earnings Growth And 8.9% ROE

It is quite clear that Al Dhafra Insurance Company P.S.C's ROE is rather low. Further, we noted that the company's ROE is similar to the industry average of 9.6%. Given the low ROE Al Dhafra Insurance Company P.S.C's five year net income decline of 14% is not surprising.

Furthermore, even when compared to the industry, which has been shrinking its earnings at a rate of 5.0% over the last few years, we found that Al Dhafra Insurance Company P.S.C's performance is pretty disappointing, as it suggests that the company has been shrunk its earnings at a rate faster than the industry.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Al Dhafra Insurance Company P.S.C is trading on a high P/E or a low P/E, relative to its industry.

Is Al Dhafra Insurance Company P.S.C Using Its Retained Earnings Effectively?

Al Dhafra Insurance Company P.S.C has a high three-year median payout ratio of 88% (that is, it is retaining 12% of its profits). This suggests that the company is paying most of its profits as dividends to its shareholders. This goes some way in explaining why its earnings have been shrinking. With only very little left to reinvest into the business, growth in earnings is far from likely. Our risks dashboard should have the 2 risks we have identified for Al Dhafra Insurance Company P.S.C.

Additionally, Al Dhafra Insurance Company P.S.C has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth.

Summary

In total, we would have a hard think before deciding on any investment action concerning Al Dhafra Insurance Company P.S.C. The company has seen a lack of earnings growth as a result of retaining very little profits and whatever little it does retain, is being reinvested at a very low rate of return. Until now, we have only just grazed the surface of the company's past performance by looking at the company's fundamentals. So it may be worth checking this free detailed graph of Al Dhafra Insurance Company P.S.C's past earnings, as well as revenue and cash flows to get a deeper insight into the company's performance.

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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.