Admiral Group plc's (LON:ADM) Stock Has Shown Weakness Lately But Financial Prospects Look Decent: Is The Market Wrong?

It is hard to get excited after looking at Admiral Group's (LON:ADM) recent performance, when its stock has declined 2.2% over the past week. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. In this article, we decided to focus on Admiral Group'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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

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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 Admiral Group is:

48% = UK£663m ÷ UK£1.4b (Based on the trailing twelve months to December 2024).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every £1 worth of equity, the company was able to earn £0.48 in profit.

View our latest analysis for Admiral Group

What Is The Relationship Between ROE And 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.

Admiral Group's Earnings Growth And 48% ROE

First thing first, we like that Admiral Group has an impressive ROE. Second, a comparison with the average ROE reported by the industry of 15% also doesn't go unnoticed by us. Needless to say, we are quite surprised to see that Admiral Group's net income shrunk at a rate of 4.4% over the past five years. Based on this, we feel that there might be other reasons which haven't been discussed so far in this article that could be hampering the company's growth. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.

From the 5.3% decline reported by the industry in the same period, we infer that Admiral Group and its industry are both shrinking at a similar rate.

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. Is ADM fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Admiral Group Efficiently Re-investing Its Profits?

Admiral Group's declining earnings is not surprising given how the company is spending most of its profits in paying dividends, judging by its three-year median payout ratio of 67% (or a retention ratio of 33%). With only very little left to reinvest into the business, growth in earnings is far from likely. You can see the 2 risks we have identified for Admiral Group by visiting our risks dashboard for free on our platform here.

Additionally, Admiral Group has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 93% over the next three years. Despite the higher expected payout ratio, the company's ROE is not expected to change by much.

Conclusion

Overall, we feel that Admiral Group certainly does have some positive factors to consider. 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. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.