United Fire Group, Inc. (NASDAQ:UFCS) Stock Is Going Strong But Fundamentals Look Uncertain: What Lies Ahead ?

By
Simply Wall St
Published
February 16, 2022
NasdaqGS:UFCS
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United Fire Group's (NASDAQ:UFCS) stock is up by a considerable 30% over the past three months. But the company's key financial indicators appear to be differing across the board and that makes us question whether or not the company's current share price momentum can be maintained. In this article, we decided to focus on United Fire Group'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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for United Fire Group

How Do You Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for United Fire Group is:

1.7% = US$14m ÷ US$815m (Based on the trailing twelve months to September 2021).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.02 in profit.

What Is The Relationship Between ROE And 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. 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.

United Fire Group's Earnings Growth And 1.7% ROE

As you can see, United Fire Group's ROE looks pretty weak. Even when compared to the industry average of 11%, the ROE figure is pretty disappointing. For this reason, United Fire Group's five year net income decline of 56% is not surprising given its lower ROE. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

That being said, we compared United Fire 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 12% in the same period.

past-earnings-growth
NasdaqGS:UFCS Past Earnings Growth February 16th 2022

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. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if United Fire Group is trading on a high P/E or a low P/E, relative to its industry.

Is United Fire Group Efficiently Re-investing Its Profits?

Looking at its three-year median payout ratio of 38% (or a retention ratio of 62%) which is pretty normal, United Fire Group's declining earnings is rather baffling as one would expect to see a fair bit of growth when a company is retaining a good portion of its profits. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

In addition, United Fire Group has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 43% of its profits over the next three years. Regardless, the future ROE for United Fire Group is predicted to rise to 3.7% despite there being not much change expected in its payout ratio.

Conclusion

In total, we're a bit ambivalent about United Fire Group's performance. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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