Arthur J. Gallagher (NYSE:AJG) has had a great run on the share market with its stock up by a significant 15% over the last three months. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. Specifically, we decided to study Arthur J. Gallagher's ROE in this article.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
How Is ROE Calculated?
ROE can be calculated by using the formula:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Arthur J. Gallagher is:
14% = US$858m ÷ US$6.2b (Based on the trailing twelve months to December 2020).
The 'return' is the profit over the last twelve months. That means that for every $1 worth of shareholders' equity, the company generated $0.14 in profit.
What Has ROE Got To Do With Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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 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.
Arthur J. Gallagher's Earnings Growth And 14% ROE
To start with, Arthur J. Gallagher's ROE looks acceptable. Further, the company's ROE compares quite favorably to the industry average of 9.0%. Probably as a result of this, Arthur J. Gallagher was able to see a decent growth of 15% over the last five years.
Next, on comparing with the industry net income growth, we found that Arthur J. Gallagher's growth is quite high when compared to the industry average growth of 5.4% in the same period, which is great to see.
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. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Arthur J. Gallagher's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Arthur J. Gallagher Making Efficient Use Of Its Profits?
Arthur J. Gallagher has a healthy combination of a moderate three-year median payout ratio of 47% (or a retention ratio of 53%) and a respectable amount of growth in earnings as we saw above, meaning that the company has been making efficient use of its profits.
Moreover, Arthur J. Gallagher is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 36% over the next three years. Regardless, the future ROE for Arthur J. Gallagher is predicted to decline to 11% 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.
On the whole, we feel that Arthur J. Gallagher's performance has been quite good. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. 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. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.
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This article by Simply Wall St is general in nature. 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.
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