With its stock down 11% over the past three months, it is easy to disregard AMERISAFE (NASDAQ:AMSF). However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Specifically, we decided to study AMERISAFE's ROE in this article.
Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Put another way, it reveals the company's success at turning shareholder investments into profits.
How To 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 AMERISAFE is:
19% = US$90m ÷ US$463m (Based on the trailing twelve months to June 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 $0.19 in profit.
Why Is ROE Important For 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.
AMERISAFE's Earnings Growth And 19% ROE
To begin with, AMERISAFE seems to have a respectable ROE. Especially when compared to the industry average of 8.1% the company's ROE looks pretty impressive. Despite this, AMERISAFE's five year net income growth was quite low averaging at only 3.4%. That's a bit unexpected from a company which has such a high rate of return. A few likely reasons why this could happen is that the company could have a high payout ratio or the business has allocated capital poorly, for instance.
As a next step, we compared AMERISAFE'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 8.2% in the same period.
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. This then helps them determine if the stock is placed for a bright or bleak future. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if AMERISAFE is trading on a high P/E or a low P/E, relative to its industry.
Is AMERISAFE Making Efficient Use Of Its Profits?
A low three-year median payout ratio of 24% (implying that the company retains the remaining 76% of its income) suggests that AMERISAFE is retaining most of its profits. This should be reflected in its earnings growth number, but that's not the case. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.
Additionally, AMERISAFE has paid dividends over a period of eight years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth.
Overall, we feel that AMERISAFE certainly does have some positive factors to consider. 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. 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 latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.
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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