With its stock down 8.6% over the past week, it is easy to disregard American Financial Group (NYSE:AFG). However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Particularly, we will be paying attention to American Financial Group’s ROE today.
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.
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How Is ROE Calculated?
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 American Financial Group is:
21% = US$853m ÷ US$4.0b (Based on the trailing twelve months to June 2023).
The ‘return’ is the yearly profit. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.21 in profit.
What Is The Relationship Between ROE And Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 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.
American Financial Group’s Earnings Growth And 21% ROE
At first glance, American Financial Group seems to have a decent ROE. Further, the company’s ROE compares quite favorably to the industry average of 11%. This probably laid the ground for American Financial Group’s moderate 13% net income growth seen over the past five years.
We then performed a comparison between American Financial Group’s net income growth with the industry, which revealed that the company’s growth is similar to the average industry growth of 12% in the same 5-year period.
Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company’s expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is AFG fairly valued? This infographic on the company’s intrinsic value has everything you need to know.
Is American Financial Group Making Efficient Use Of Its Profits?
In American Financial Group’s case, its respectable earnings growth can probably be explained by its low three-year median payout ratio of 23% (or a retention ratio of 77%), which suggests that the company is investing most of its profits to grow its business.
Besides, American Financial Group has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders.
Overall, we are quite pleased with American Financial Group’s performance. In particular, it’s great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. We also studied the latest analyst forecasts and found that the company’s earnings growth is expected be similar to its current growth rate. 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. 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.