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CNA Financial (NYSE:CNA) has had a great run on the share market with its stock up by a significant 30% over the last three months. But the company's key financial indicators appear to be differing across the board and that makes us question whether or not the company's current share price momentum can be maintained. Specifically, we decided to study CNA Financial'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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
How Do You Calculate Return On Equity?
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 CNA Financial is:
4.8% = US$576m ÷ US$12b (Based on the trailing twelve months to September 2020).
The 'return' is the profit over the last twelve months. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.05.
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 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.
CNA Financial's Earnings Growth And 4.8% ROE
At first glance, CNA Financial's ROE doesn't look very promising. Next, when compared to the average industry ROE of 8.3%, the company's ROE leaves us feeling even less enthusiastic. As a result, CNA Financial reported a very low income growth of 2.8% over the past five years.
As a next step, we compared CNA Financial'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 6.8% 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. Doing so will help them establish if the stock's future looks promising or ominous. What is CNA worth today? The intrinsic value infographic in our free research report helps visualize whether CNA is currently mispriced by the market.
Is CNA Financial Making Efficient Use Of Its Profits?
Despite having a normal three-year median payout ratio of 42% (or a retention ratio of 58% over the past three years, CNA Financial has seen very little growth in earnings as we saw above. Therefore, there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.
Additionally, CNA Financial 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. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 85% over the next three years. Still, forecasts suggest that CNA Financial's future ROE will rise to 9.5% 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 CNA Financial 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 analyst forecasts show that the company will continue to see an expansion in its earnings. 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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