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James River Group Holdings, Ltd.'s (NASDAQ:JRVR) Dismal Stock Performance Reflects Weak Fundamentals

Simply Wall St
·4 min read

With its stock down 7.3% over the past week, it is easy to disregard James River Group Holdings (NASDAQ:JRVR). We decided to study the company's financials to determine if the downtrend will continue as the long-term performance of a company usually dictates market outcomes. In this article, we decided to focus on James River Group Holdings' ROE.

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for James River Group Holdings

How Do You Calculate Return On Equity?

Return on equity 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 James River Group Holdings is:

5.5% = US$46m ÷ US$821m (Based on the trailing twelve months to September 2020).

The 'return' is the income the business earned over the last year. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.06 in profit.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.

James River Group Holdings' Earnings Growth And 5.5% ROE

When you first look at it, James River Group Holdings' ROE doesn't look that attractive. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 8.3% either. Therefore, it might not be wrong to say that the five year net income decline of 16% seen by James River Group Holdings was probably the result of it having a lower ROE. However, there could also be other factors causing the earnings to decline. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

However, when we compared James River Group Holdings' growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 8.0% in the same period. This is quite worrisome.

past-earnings-growth
past-earnings-growth

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. Doing so will help them establish if the stock's future looks promising or ominous. 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 James River Group Holdings is trading on a high P/E or a low P/E, relative to its industry.

Is James River Group Holdings Efficiently Re-investing Its Profits?

James River Group Holdings' declining earnings is not surprising given how the company is spending most of its profits in paying dividends, judging by its three-year median payout ratio of 68% (or a retention ratio of 32%). With only a little being reinvested into the business, earnings growth would obviously be low or non-existent.

In addition, James River Group Holdings has been paying dividends over a period of six years suggesting that keeping up dividend payments is preferred by the management even though earnings have been in decline. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 46% over the next three years.

Conclusion

Overall, we would be extremely cautious before making any decision on James River Group Holdings. The company has seen a lack of earnings growth as a result of retaining very little profits and whatever little it does retain, is being reinvested at a very low rate of return. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com.