Does Gulf Insurance Group's (TADAWUL:8250) Weak Fundamentals Mean That The Market Could Correct Its Share Price?

Most readers would already be aware that Gulf Insurance Group's (TADAWUL:8250) stock increased significantly by 14% over the past three months. However, we decided to pay close attention to its weak financials as we are doubtful that the current momentum will keep up, given the scenario. In this article, we decided to focus on Gulf Insurance Group's ROE.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for Gulf Insurance Group

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 Gulf Insurance Group is:

6.4% = ر.س64m ÷ ر.س1b (Based on the trailing twelve months to June 2024).

The 'return' is the income the business earned over the last year. So, this means that for every SAR1 of its shareholder's investments, the company generates a profit of SAR0.06.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. 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.

Gulf Insurance Group's Earnings Growth And 6.4% ROE

As you can see, Gulf Insurance Group's ROE looks pretty weak. Not just that, even compared to the industry average of 11%, the company's ROE is entirely unremarkable. Given the circumstances, the significant decline in net income by 9.6% seen by Gulf Insurance Group over the last five years is not surprising. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. For example, the business has allocated capital poorly, or that the company has a very high payout ratio.

That being said, we compared Gulf Insurance Group's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 19% in the same 5-year period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Gulf Insurance Group fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Gulf Insurance Group Efficiently Re-investing Its Profits?

With a high three-year median payout ratio of 61% (implying that 39% of the profits are retained), most of Gulf Insurance Group's profits are being paid to shareholders, which explains the company's shrinking earnings. With only very little left to reinvest into the business, growth in earnings is far from likely.

Additionally, Gulf Insurance Group started paying a dividend only recently. So it looks like the management may have perceived that shareholders favor dividends even though earnings have been in decline.

Conclusion

Overall, we would be extremely cautious before making any decision on Gulf Insurance Group. Because the company is not reinvesting much into the business, and given the low ROE, it's not surprising to see the lack or absence of growth in its earnings. 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 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.