HDFC Life Insurance Company Limited's (NSE:HDFCLIFE) Financials Are Too Obscure To Link With Current Share Price Momentum: What's In Store For the Stock?

HDFC Life Insurance (NSE:HDFCLIFE) has had a great run on the share market with its stock up by a significant 29% over the last three months. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. In this article, we decided to focus on HDFC Life Insurance'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.

See our latest analysis for HDFC Life Insurance

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 HDFC Life Insurance is:

11% = ₹16b ÷ ₹153b (Based on the trailing twelve months to June 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 ₹0.11 in profit.

What Has ROE Got To Do With 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.

HDFC Life Insurance's Earnings Growth And 11% ROE

On the face of it, HDFC Life Insurance's ROE is not much to talk about. Yet, a closer study shows that the company's ROE is similar to the industry average of 9.8%. We can see that HDFC Life Insurance has grown at a five year net income growth average rate of 3.8%, which is a bit on the lower side. Remember, the company's ROE is not particularly great to begin with. So this could also be one of the reasons behind the company's low growth in earnings.

Next, on comparing with the industry net income growth, we found that HDFC Life Insurance's reported growth was lower than the industry growth of 15% over the last few years, which is not something we like to see.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. If you're wondering about HDFC Life Insurance's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is HDFC Life Insurance Using Its Retained Earnings Effectively?

Despite having a normal three-year median payout ratio of 28% (or a retention ratio of 72% over the past three years, HDFC Life Insurance has seen very little growth in earnings as we saw above. Therefore, there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Moreover, HDFC Life Insurance has been paying dividends for seven years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 28%. However, HDFC Life Insurance's ROE is predicted to rise to 13% despite there being no anticipated change in its payout ratio.

Summary

Overall, we have mixed feelings about HDFC Life Insurance. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com