Old Republic International (NYSE:ORI) has had a great run on the share market with its stock up by a significant 15% over the last month. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. Specifically, we decided to study Old Republic International's 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. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
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 Old Republic International is:
5.2% = US$315m ÷ US$6.1b (Based on the trailing twelve months to September 2020).
The 'return' refers to a company's earnings over the last year. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.05.
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. 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.
A Side By Side comparison of Old Republic International's Earnings Growth And 5.2% ROE
On the face of it, Old Republic International's ROE is not much to talk about. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 8.1% either. Accordingly, Old Republic International's low net income growth of 3.7% over the past five years can possibly be explained by the low ROE amongst other factors.
As a next step, we compared Old Republic International'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 7.5% in the same period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Has the market priced in the future outlook for ORI? You can find out in our latest intrinsic value infographic research report.
Is Old Republic International Making Efficient Use Of Its Profits?
Despite having a moderate three-year median payout ratio of 39% (implying that the company retains the remaining 61% of its income), Old Republic International's earnings growth was quite low. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.
Additionally, Old Republic International 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. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 48% over the next three years.
Overall, we have mixed feelings about Old Republic International. 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. 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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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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