Declining Stock and Solid Fundamentals: Is The Market Wrong About Hiscox Ltd (LON:HSX)?

With its stock down 7.1% over the past three months, it is easy to disregard Hiscox (LON:HSX). However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Particularly, we will be paying attention to Hiscox'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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

View our latest analysis for Hiscox

How Is ROE Calculated?

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 Hiscox is:

21% = US$721m ÷ US$3.4b (Based on the trailing twelve months to June 2024).

The 'return' is the yearly profit. So, this means that for every £1 of its shareholder's investments, the company generates a profit of £0.21.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.

Hiscox's Earnings Growth And 21% ROE

At first glance, Hiscox seems to have a decent ROE. Further, the company's ROE compares quite favorably to the industry average of 14%. This probably laid the ground for Hiscox's significant 61% net income growth seen over the past five years. However, there could also be other causes behind this growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

When you consider the fact that the industry earnings have shrunk at a rate of 21% in the same 5-year period, the company's net income growth is pretty remarkable.

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Hiscox fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Hiscox Using Its Retained Earnings Effectively?

The three-year median payout ratio for Hiscox is 35%, which is moderately low. The company is retaining the remaining 65%. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like Hiscox is reinvesting its earnings efficiently.

Additionally, Hiscox has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 34%. Regardless, Hiscox's ROE is speculated to decline to 14% despite there being no anticipated change in its payout ratio.

Summary

In total, we are pretty happy with Hiscox's performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. That being so, according to the latest industry analyst forecasts, the company's earnings are expected to shrink in the future. 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.