Chubb Limited (NYSE:CB) Is Going Strong But Fundamentals Appear To Be Mixed : Is There A Clear Direction For The Stock?
Most readers would already be aware that Chubb's (NYSE:CB) stock increased significantly by 26% over the past month. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. Particularly, we will be paying attention to Chubb's ROE today.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
See our latest analysis for Chubb
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 Chubb is:
4.1% = US$2.3b ÷ US$56b (Based on the trailing twelve months to September 2020).
The 'return' is the yearly profit. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.04.
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. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.
Chubb's Earnings Growth And 4.1% ROE
It is quite clear that Chubb's ROE is rather low. Not just that, even compared to the industry average of 8.3%, the company's ROE is entirely unremarkable. Hence, the flat earnings seen by Chubb over the past five years could probably be the result of it having a lower ROE.
As a next step, we compared Chubb'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.
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. Doing so will help them establish if the stock's future looks promising or ominous. Is Chubb fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Chubb Using Its Retained Earnings Effectively?
In spite of a normal three-year median payout ratio of 34% (or a retention ratio of 66%), Chubb hasn't seen much growth in its earnings. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.
Additionally, Chubb 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. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 27% over the next three years. As a result, the expected drop in Chubb's payout ratio explains the anticipated rise in the company's future ROE to 8.7%, over the same period.
Summary
Overall, we have mixed feelings about Chubb. 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. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page 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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