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

It is hard to get excited after looking at Hiscox's (LON:HSX) recent performance, when its stock has declined 4.6% over the past three months. 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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for Hiscox

How To Calculate Return On Equity?

Return on equity 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. Another way to think of that is that for every £1 worth of equity, the company was able to earn £0.21 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. 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.

A Side By Side comparison of Hiscox's Earnings Growth And 21% ROE

At first glance, Hiscox seems to have a decent ROE. On comparing with the average industry ROE of 14% the company's ROE looks pretty remarkable. This probably laid the ground for Hiscox's significant 61% net income growth seen over the past five years. We believe that there might also be other aspects that are positively influencing the company's earnings growth. Such as - high earnings retention or an efficient management in place.

Next, on comparing with the industry net income growth, we found that the growth figure reported by Hiscox compares quite favourably to the industry average, which shows a decline of 21% over the last few years.

Earnings growth is a huge factor in stock valuation. 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. Is Hiscox fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Hiscox Making Efficient Use Of Its Profits?

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.

Besides, Hiscox has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 22% over the next three years. Still forecasts suggest that Hiscox's future ROE will drop to 14% even though the the company's payout ratio is expected to decrease. This suggests that there could be other factors could driving the anticipated decline in the company's ROE.

Summary

On the whole, we feel that Hiscox's performance has been quite good. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. With that said, on studying the latest analyst forecasts, we found that while the company has seen growth in its past earnings, analysts expect its future earnings to shrink. 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.