Are Strong Financial Prospects The Force That Is Driving The Momentum In Islamic Arab Insurance Co. (Salama) PJSC's DFM:SALAMA) Stock?

Islamic Arab Insurance (Salama) PJSC's (DFM:SALAMA) stock is up by a considerable 14% over the past month. 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 Islamic Arab Insurance (Salama) PJSC'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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Islamic Arab Insurance (Salama) PJSC

How Do You Calculate Return On Equity?

The formula for return on equity is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Islamic Arab Insurance (Salama) PJSC is:

17% = د.إ160m ÷ د.إ934m (Based on the trailing twelve months to September 2020).

The 'return' is the yearly profit. Another way to think of that is that for every AED1 worth of equity, the company was able to earn AED0.17 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 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.

Islamic Arab Insurance (Salama) PJSC's Earnings Growth And 17% ROE

On the face of it, Islamic Arab Insurance (Salama) PJSC's ROE is not much to talk about. However, the fact that the company's ROE is higher than the average industry ROE of 11%, is definitely interesting. Even more so after seeing Islamic Arab Insurance (Salama) PJSC's exceptional 62% net income growth over the past five years. That being said, the company does have a slightly low ROE to begin with, just that it is higher than the industry average. So, there might well be other reasons for the earnings to grow. E.g the company has a low payout ratio or could belong to a high growth industry.

As a next step, we compared Islamic Arab Insurance (Salama) PJSC's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 14%.

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. Doing so will help them establish if the stock's future looks promising or ominous. Is Islamic Arab Insurance (Salama) PJSC fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Islamic Arab Insurance (Salama) PJSC Making Efficient Use Of Its Profits?

The three-year median payout ratio for Islamic Arab Insurance (Salama) PJSC is 42%, which is moderately low. The company is retaining the remaining 58%. So it seems that Islamic Arab Insurance (Salama) PJSC is reinvesting efficiently in a way that it sees impressive growth in its earnings (discussed above) and pays a dividend that's well covered.

Conclusion

In total, we are pretty happy with Islamic Arab Insurance (Salama) PJSC's performance. Particularly, we like that the company is reinvesting heavily into its business at a moderate rate of return. Unsurprisingly, this has led to an impressive earnings growth. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Let's not forget, business risk is also one of the factors that affects the price of the stock. So this is also an important area that investors need to pay attention to before making a decision on any business. You can see the 1 risk we have identified for Islamic Arab Insurance (Salama) PJSC by visiting our risks dashboard for free on our platform here.

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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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