Sun Life Financial's (TSE:SLF) stock is up by a considerable 14% over the past three months. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Particularly, we will be paying attention to Sun Life 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. 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?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Sun Life Financial is:
9.7% = CA$2.5b ÷ CA$26b (Based on the trailing twelve months to December 2020).
The 'return' refers to a company's earnings over the last year. So, this means that for every CA$1 of its shareholder's investments, the company generates a profit of CA$0.10.
Why Is ROE Important For Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. 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.
Sun Life Financial's Earnings Growth And 9.7% ROE
To begin with, Sun Life Financial seems to have a respectable ROE. Further, the company's ROE is similar to the industry average of 11%. Despite this, Sun Life Financial's five year net income growth was quite flat over the past five years. So, there could be some other aspects that could potentially be preventing the company from growing. These include low earnings retention or poor allocation of capital.
We then compared Sun Life Financial's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 6.0% in the same period, which is a bit concerning.
Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. What is SLF worth today? The intrinsic value infographic in our free research report helps visualize whether SLF is currently mispriced by the market.
Is Sun Life Financial Making Efficient Use Of Its Profits?
Despite having a normal three-year median payout ratio of 50% (implying that the company keeps 50% of its income) over the last three years, Sun Life Financial has seen a negligible amount of growth in earnings as we saw above. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.
Moreover, Sun Life Financial 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. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 37% over the next three years. As a result, the expected drop in Sun Life Financial's payout ratio explains the anticipated rise in the company's future ROE to 14%, over the same period.
On the whole, we do feel that Sun Life Financial has some positive attributes. However, given the high ROE and high profit retention, we would expect the company to be delivering strong earnings growth, but that isn't the case here. This suggests that there might be some external threat to the business, that's hampering its growth. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.
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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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