Declining Stock and Decent Financials: Is The Market Wrong About Línea Directa Aseguradora, S.A. (BME:LDA)?

With its stock down 14% over the past three months, it is easy to disregard Línea Directa Aseguradora (BME:LDA). However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Particularly, we will be paying attention to Línea Directa Aseguradora's ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Línea Directa Aseguradora

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 Línea Directa Aseguradora is:

32% = €122m ÷ €384m (Based on the trailing twelve months to September 2021).

The 'return' is the yearly profit. That means that for every €1 worth of shareholders' equity, the company generated €0.32 in profit.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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 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.

A Side By Side comparison of Línea Directa Aseguradora's Earnings Growth And 32% ROE

Firstly, we acknowledge that Línea Directa Aseguradora has a significantly high ROE. Secondly, even when compared to the industry average of 8.8% the company's ROE is quite impressive. Despite this, Línea Directa Aseguradora's five year net income growth was quite low averaging at only 4.6%. This is generally not the case as when a company has a high rate of return it should usually also have a high earnings growth rate. Such a scenario is likely to take place when a company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.

We then compared Línea Directa Aseguradora's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 7.2% in the same period, which is a bit concerning.

Earnings growth is an important metric to consider when valuing a stock. 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. What is LDA worth today? The intrinsic value infographic in our free research report helps visualize whether LDA is currently mispriced by the market.

Is Línea Directa Aseguradora Using Its Retained Earnings Effectively?

Despite having a normal three-year median payout ratio of 29% (or a retention ratio of 71% over the past three years, Línea Directa Aseguradora has seen very little 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.

Only recently, Línea Directa Aseguradora started paying a dividend. This means that the management might have concluded that its shareholders prefer dividends over earnings growth. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 91% over the next three years. Regardless, the ROE is not expected to change much for the company despite the higher expected payout ratio.

Conclusion

On the whole, we do feel that Línea Directa Aseguradora has some positive attributes. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return and is reinvesting ma huge portion of its profits. By the looks of it, there could be some other factors, not necessarily in control of the business, that's preventing growth. On studying current analyst estimates, we found that analysts expect the company to continue its recent growth streak. 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.