Hiscox Ltd's (LON:HSX) Stock Is Going Strong: Is the Market Following Fundamentals?

Hiscox's (LON:HSX) stock is up by a considerable 16% over the past month. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on Hiscox's ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for Hiscox

How To Calculate Return On Equity?

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 Hiscox is:

22% = US$712m ÷ US$3.3b (Based on the trailing twelve months to December 2023).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every £1 of its shareholder's investments, the company generates a profit of £0.22.

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. 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 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.

Hiscox's Earnings Growth And 22% ROE

At first glance, Hiscox seems to have a decent ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 19%. Consequently, this likely laid the ground for the impressive net income growth of 44% seen over the past five years by Hiscox. 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.

Given that the industry shrunk its earnings at a rate of 7.2% over the last few years, the net income growth of the company is quite impressive.

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. Is Hiscox fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Hiscox Making Efficient Use Of Its Profits?

Hiscox's significant three-year median payout ratio of 81% (where it is retaining only 19% of its income) suggests that the company has been able to achieve a high growth in earnings despite returning most of its income to shareholders.

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 27% over the next three years. Regardless, the future ROE for Hiscox is predicted to decline to 17% despite the anticipated decrease in the payout ratio. We reckon that there could probably be other factors that could be driving the forseen decline in the company's ROE.

Conclusion

On the whole, we feel that Hiscox's performance has been quite good. Especially the high ROE, Which has contributed to the impressive growth seen in earnings. Despite the company reinvesting only a small portion of its profits, it still has managed to grow its earnings so that is appreciable. Having said that, on studying current analyst estimates, we were concerned to see that while the company has grown its earnings in the past, analysts expect its earnings to shrink in the future. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.