PSC Insurance Group Limited's (ASX:PSI) Fundamentals Look Pretty Strong: Could The Market Be Wrong About The Stock?

With its stock down 11% over the past month, it is easy to disregard PSC Insurance Group (ASX:PSI). However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Specifically, we decided to study PSC Insurance Group's ROE in this article.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for PSC Insurance Group

How To 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 PSC Insurance Group is:

13% = AU$44m ÷ AU$346m (Based on the trailing twelve months to December 2021).

The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every A$1 worth of equity, the company was able to earn A$0.13 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.

PSC Insurance Group's Earnings Growth And 13% ROE

To begin with, PSC Insurance Group seems to have a respectable ROE. On comparing with the average industry ROE of 9.9% the company's ROE looks pretty remarkable. This probably laid the ground for PSC Insurance Group's moderate 12% net income growth seen over the past five years.

We then compared PSC Insurance Group's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 6.9% in the same period.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about PSC Insurance Group's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is PSC Insurance Group Using Its Retained Earnings Effectively?

The high three-year median payout ratio of 93% (or a retention ratio of 7.3%) for PSC Insurance Group suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.

Moreover, PSC Insurance Group is determined to keep sharing its profits with shareholders which we infer from its long history of six years of paying a dividend. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 60% over the next three years. Regardless, the ROE is not expected to change much for the company despite the lower expected payout ratio.

Conclusion

On the whole, we do feel that PSC Insurance Group has some positive attributes. Namely, its high earnings growth, which was likely due to its high ROE. However, investors could have benefitted even more from the high ROE, had the company been reinvesting more of its earnings. As discussed earlier, the company is retaining hardly any of its profits. The latest industry analyst forecasts show that the company is expected to maintain its current growth rate. 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. 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.