Most readers would already be aware that Cigna's (NYSE:CI) stock increased significantly by 10% over the past three months. 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 Cigna'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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
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 Cigna is:
11% = US$5.4b ÷ US$47b (Based on the trailing twelve months to December 2021).
The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $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. 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.
Cigna's Earnings Growth And 11% ROE
To begin with, Cigna seems to have a respectable ROE. Even so, when compared with the average industry ROE of 16%, we aren't very excited. That being the case, the significant five-year 31% net income growth reported by Cigna comes as a pleasant surprise. Therefore, there could 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. However, not to forget, the company does have a decent ROE to begin with, just that it is lower than the industry average. So this certainly also provides some context to the high earnings growth seen by the company.
We then compared Cigna's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 17% in the same period.
Earnings growth is an important metric to consider when valuing a stock. 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 CI fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is Cigna Using Its Retained Earnings Effectively?
Cigna's ' three-year median payout ratio is on the lower side at 0.3% implying that it is retaining a higher percentage (100%) of its profits. This suggests that the management is reinvesting most of the profits to grow the business as evidenced by the growth seen by the company.
Additionally, Cigna 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 is expected to rise to 16% over the next three years. Regardless, the future ROE for Cigna is speculated to rise to 16% despite the anticipated increase in the payout ratio. There could probably be other factors that could be driving the future growth in the ROE.
Overall, we are quite pleased with Cigna's performance. Particularly, we like that the company is reinvesting heavily into its business at a moderate rate of return. Unsurprisingly, this has led to an impressive earnings growth. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. 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.
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.