CNA Financial's (NYSE:CNA) stock is up by 9.5% over the past three months. Given that the stock prices usually follow long-term business performance, we wonder if the company's mixed financials could have any adverse effect on its current price price movement Specifically, we decided to study CNA Financial'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 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 ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for CNA Financial is:
9.4% = US$1.2b ÷ US$13b (Based on the trailing twelve months to December 2021).
The 'return' is the amount earned after tax over the last twelve months. That means that for every $1 worth of shareholders' equity, the company generated $0.09 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 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.
CNA Financial's Earnings Growth And 9.4% ROE
On the face of it, CNA Financial's ROE is not much to talk about. However, its ROE is similar to the industry average of 11%, so we won't completely dismiss the company. However, CNA Financial has seen a flattish net income growth over the past five years, which is not saying much. Remember, the company's ROE is not particularly great to begin with. Hence, this provides some context to the flat earnings growth seen by the company.
As a next step, we compared CNA Financial's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 13% in the same 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). This then helps them determine if the stock is placed for a bright or bleak future. Has the market priced in the future outlook for CNA? You can find out in our latest intrinsic value infographic research report.
Is CNA Financial Making Efficient Use Of Its Profits?
In spite of a normal three-year median payout ratio of 43% (or a retention ratio of 57%), CNA Financial hasn't seen much growth in its earnings. Therefore, there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.
Moreover, CNA Financial has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 82% over the next three years. However, the company's ROE is not expected to change by much despite the higher expected payout ratio.
In total, we're a bit ambivalent about CNA Financial's performance. 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. 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.
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.