Are ProAssurance Corporation's (NYSE:PRA) Mixed Financials Driving The Negative Sentiment?
It is hard to get excited after looking at ProAssurance's (NYSE:PRA) recent performance, when its stock has declined 13% over the past three months. We, however decided to study the company's financials to determine if they have got anything to do with the price decline. Fundamentals usually dictate market outcomes so it makes sense to study the company's financials. Specifically, we decided to study ProAssurance's ROE in this article.
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 ProAssurance
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 ProAssurance is:
1.7% = US$18m ÷ US$1.1b (Based on the trailing twelve months to September 2022).
The 'return' is the income the business earned over the last year. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.02.
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. 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.
A Side By Side comparison of ProAssurance's Earnings Growth And 1.7% ROE
It is quite clear that ProAssurance's ROE is rather low. Not just that, even compared to the industry average of 13%, the company's ROE is entirely unremarkable. Given the circumstances, the significant decline in net income by 20% seen by ProAssurance over the last five years is not surprising. We reckon that there could also be other factors at play here. For example, the business has allocated capital poorly, or that the company has a very high payout ratio.
So, as a next step, we compared ProAssurance's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 13% in the same period.
Earnings growth is an important metric to consider when valuing a stock. 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. Is ProAssurance fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is ProAssurance Efficiently Re-investing Its Profits?
ProAssurance's low three-year median payout ratio of 7.5% (or a retention ratio of 93%) over the last three years should mean that the company is retaining most of its earnings to fuel its growth but the company's earnings have actually shrunk. This typically shouldn't be the case when a company is retaining most of its earnings. So there might be other factors at play here which could potentially be hampering growth. For instance, the business has faced some headwinds.
Moreover, ProAssurance 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. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 25% over the next three years. Still, forecasts suggest that ProAssurance's future ROE will rise to 5.7% even though the the company's payout ratio is expected to rise. We presume that there could some other characteristics of the business that could be driving the anticipated growth in the company's ROE.
On the whole, we feel that the performance shown by ProAssurance can be open to many interpretations. 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. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. 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. 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.
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