Employers Holdings, Inc. (NYSE:EIG) Is Going Strong But Fundamentals Appear To Be Mixed : Is There A Clear Direction For The Stock?

Employers Holdings (NYSE:EIG) has had a great run on the share market with its stock up by a significant 21% over the last month. 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. Specifically, we decided to study Employers Holdings' ROE in this article.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for Employers Holdings

How To Calculate Return On Equity?

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 Employers Holdings is:

9.9% = US$120m ÷ US$1.2b (Based on the trailing twelve months to December 2020).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.10 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. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.

Employers Holdings' Earnings Growth And 9.9% ROE

On the face of it, Employers Holdings' ROE is not much to talk about. However, its ROE is similar to the industry average of 9.0%, so we won't completely dismiss the company. We can see that Employers Holdings has grown at a five year net income growth average rate of 4.1%, which is a bit on the lower side. Remember, the company's ROE is not particularly great to begin with. Hence, this does provide some context to low earnings growth seen by the company.

As a next step, we compared Employers Holdings' net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 6.2% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. Is Employers Holdings fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Employers Holdings Making Efficient Use Of 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. This should be reflected in its earnings growth number, but that's not the case. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Moreover, Employers Holdings 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 56% over the next three years. Therefore, the expected rise in the payout ratio explains why the company's ROE is expected to decline to 4.8% over the same period.

Conclusion

In total, we're a bit ambivalent about Employers Holdings' performance. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. Having said that, on studying current analyst estimates, we were concerned to see that while the company has grown its earnings in the past, analysts expect its earnings to shrink in the future. 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.

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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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