Is Erie Indemnity Company's (NASDAQ:ERIE) Recent Stock Performance Influenced By Its Fundamentals In Any Way?
Most readers would already be aware that Erie Indemnity's (NASDAQ:ERIE) stock increased significantly by 39% over the past month. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. In this article, we decided to focus on Erie Indemnity's ROE.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
Check out our latest analysis for Erie Indemnity
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 Erie Indemnity is:
23% = US$354m ÷ US$1.5b (Based on the trailing twelve months to June 2023).
The 'return' is the income the business earned over the last year. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.23.
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. 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.
Erie Indemnity's Earnings Growth And 23% ROE
Firstly, we acknowledge that Erie Indemnity has a significantly high ROE. Secondly, even when compared to the industry average of 11% the company's ROE is quite impressive. Despite this, Erie Indemnity's five year net income growth was quite low averaging at only 2.6%. This is generally not the case as when a company has a high rate of return it should usually also have a high earnings growth rate. Such a scenario is likely to take place when a company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.
Next, on comparing with the industry net income growth, we found that Erie Indemnity's reported growth was lower than the industry growth of 11% over the last few years, which is not something we like to see.
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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Erie Indemnity fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Erie Indemnity Efficiently Re-investing Its Profits?
Erie Indemnity has a three-year median payout ratio of 71% (implying that it keeps only 29% of its profits), meaning that it pays out most of its profits to shareholders as dividends, and as a result, the company has seen low earnings growth.
Moreover, Erie Indemnity has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth.
Summary
In total, it does look like Erie Indemnity has some positive aspects to its business. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE. Bear in mind, the company reinvests a small portion of its profits, which means that investors aren't reaping the benefits of the high rate of return. 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.
