Will ProAssurance Corporation (PRA) Continue To Underperform Its Industry?
ProAssurance Corporation (NYSE:PRA) generated a below-average return on equity of 7.44% in the past 12 months, while its industry returned 8.00%. An investor may attribute an inferior ROE to a relatively inefficient performance, and whilst this can often be the case, knowing the nuts and bolts of the ROE calculation may change that perspective and give you a deeper insight into PRA’s past performance. I will take you through how metrics such as financial leverage impact ROE which may affect the overall sustainability of PRA’s returns. See our latest analysis for PRA
Peeling the layers of ROE – trisecting a company’s profitability
Return on Equity (ROE) is a measure of PRA’s profit relative to its shareholders’ equity. It essentially shows how much PRA can generate in earnings given the amount of equity it has raised. While a higher ROE is preferred in most cases, there are several other factors we should consider before drawing any conclusions.
Return on Equity = Net Profit ÷ Shareholders Equity
Returns are usually compared to costs to measure the efficiency of capital. PRA’s cost of equity is 9.90%. Given a discrepancy of -2.47% between return and cost, this indicated that PRA may be paying more for its capital than what it’s generating in return. ROE can be dissected into three distinct ratios: net profit margin, asset turnover, and financial leverage. This is called the Dupont Formula:
Dupont Formula
ROE = profit margin × asset turnover × financial leverage
ROE = (annual net profit ÷ sales) × (sales ÷ assets) × (assets ÷ shareholders’ equity)
ROE = annual net profit ÷ shareholders’ equity
Essentially, profit margin shows how much money the company makes after paying for all its expenses. The other component, asset turnover, illustrates how much revenue PRA can make from its asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. Since ROE can be inflated by excessive debt, we need to examine PRA’s debt-to-equity level. At 21.64%, PRA’s debt-to-equity ratio appears low and indicates that PRA still has room to increase leverage and grow its profits.
What this means for you:
Are you a shareholder? PRA’s ROE is underwhelming relative to the industry average, and its returns were also not strong enough to cover its own cost of equity. Since its existing ROE is not fuelled by unsustainable debt, investors shouldn’t give up as PRA still has capacity to improve shareholder returns by borrowing to invest in new projects in the future. If you’re looking for new ideas for high-returning stocks, you should take a look at our free platform to see the list of stocks with Return on Equity over 20%.
Are you a potential investor? If you are considering investing in PRA, looking at ROE on its own is not enough to make a well-informed decision. I recommend you do additional fundamental analysis by looking through our most recent infographic report on ProAssurance to help you make a more informed investment decision.
To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned.
