Should Weakness in Personal Group Holdings Plc's (LON:PGH) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?

With its stock down 23% over the past three months, it is easy to disregard Personal Group Holdings (LON:PGH). But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. Specifically, we decided to study Personal Group Holdings' 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. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for Personal Group Holdings

How Is ROE Calculated?

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 Personal Group Holdings is:

22% = UK£8.7m ÷ UK£39m (Based on the trailing twelve months to June 2020).

The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.22 in profit.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.

Personal Group Holdings' Earnings Growth And 22% ROE

To begin with, Personal Group Holdings has a pretty high ROE which is interesting. Secondly, even when compared to the industry average of 12% the company's ROE is quite impressive. As you might expect, the 4.7% net income decline reported by Personal Group Holdings doesn't bode well with us. So, there might be some other aspects that could explain this. These include low earnings retention or poor allocation of capital.

However, when we compared Personal Group Holdings' growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 10% in the same period. This is quite worrisome.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Personal Group Holdings''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Personal Group Holdings Efficiently Re-investing Its Profits?

With a high three-year median payout ratio of 82% (implying that 18% of the profits are retained), most of Personal Group Holdings' profits are being paid to shareholders, which explains the company's shrinking earnings. The business is only left with a small pool of capital to reinvest - A vicious cycle that doesn't benefit the company in the long-run. You can see the 4 risks we have identified for Personal Group Holdings by visiting our risks dashboard for free on our platform here.

In addition, Personal Group Holdings has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth.

Conclusion

On the whole, we do feel that Personal Group Holdings has some positive attributes. However, while the company does have a high ROE, its earnings growth number is quite disappointing. This can be blamed on the fact that it reinvests only a small portion of its profits and pays out the rest as dividends. Up till now, we've only made a short study of the company's growth data. So it may be worth checking this free detailed graph of Personal Group Holdings' 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. 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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