Is Arthur J. Gallagher & Co.'s (NYSE:AJG) Recent Stock Performance Tethered To Its Strong Fundamentals?
Arthur J. Gallagher (NYSE:AJG) has had a great run on the share market with its stock up by a significant 8.0% over the last month. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on Arthur J. Gallagher's ROE.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
Check out our latest analysis for Arthur J. Gallagher
How Do You Calculate Return On Equity?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Arthur J. Gallagher is:
13% = US$1.1b ÷ US$8.6b (Based on the trailing twelve months to September 2022).
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 $0.13 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. 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.
Arthur J. Gallagher's Earnings Growth And 13% ROE
To start with, Arthur J. Gallagher's ROE looks acceptable. Further, the company's ROE is similar to the industry average of 13%. This probably goes some way in explaining Arthur J. Gallagher's moderate 15% growth over the past five years amongst other factors.
As a next step, we compared Arthur J. Gallagher's net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 13% in the same period.
Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. 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 Arthur J. Gallagher is trading on a high P/E or a low P/E, relative to its industry.
Is Arthur J. Gallagher Making Efficient Use Of Its Profits?
Arthur J. Gallagher has a healthy combination of a moderate three-year median payout ratio of 42% (or a retention ratio of 58%) and a respectable amount of growth in earnings as we saw above, meaning that the company has been making efficient use of its profits.
Besides, Arthur J. Gallagher has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 24% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 17%, over the same period.
Summary
Overall, we are quite pleased with Arthur J. Gallagher'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. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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.
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