Declining Stock and Decent Financials: Is The Market Wrong About Employers Holdings, Inc. (NYSE:EIG)?

By
Simply Wall St
Published
January 20, 2022
NYSE:EIG
Source: Shutterstock

It is hard to get excited after looking at Employers Holdings' (NYSE:EIG) recent performance, when its stock has declined 4.7% over the past week. But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. Particularly, we will be paying attention to Employers Holdings' ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for Employers Holdings

How Do You Calculate Return On Equity?

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 Employers Holdings is:

11% = US$129m ÷ US$1.2b (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 $0.11 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.

A Side By Side comparison of Employers Holdings' Earnings Growth And 11% ROE

To start with, Employers Holdings' ROE looks acceptable. Even when compared to the industry average of 11% the company's ROE looks quite decent. Despite the modest returns, Employers Holdings' five year net income growth was quite low, averaging at only 4.8%. So, there could be some other factors at play that could be impacting the company's growth. For instance, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.

Next, on comparing with the industry net income growth, we found that Employers Holdings' reported growth was lower than the industry growth of 12% in the same period, which is not something we like to see.

past-earnings-growth
NYSE:EIG Past Earnings Growth January 20th 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. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Employers Holdings''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Employers Holdings Efficiently Re-investing Its Profits?

Employers Holdings has a low three-year median payout ratio of 19% (meaning, the company keeps the remaining 81% of profits) which means that the company is retaining more of its earnings. However, the low earnings growth number doesn't reflect this as high growth usually follows high profit retention. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

Additionally, Employers Holdings has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 50% over the next three years. Consequently, the higher expected payout ratio explains the decline in the company's expected ROE (to 5.5%) over the same period.

Conclusion

On the whole, we do feel that Employers Holdings has some positive attributes. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return and is reinvesting ma huge portion of its profits. By the looks of it, there could be some other factors, not necessarily in control of the business, that's preventing growth. With that said, on studying the latest analyst forecasts, we found that while the company has seen growth in its past earnings, analysts expect its future earnings to shrink. 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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