Swiss Re AG's (VTX:SREN) Stock Has Seen Strong Momentum: Does That Call For Deeper Study Of Its Financial Prospects?
Swiss Re (VTX:SREN) has had a great run on the share market with its stock up by a significant 22% over the last three months. 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 Swiss Re's 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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
View our latest analysis for Swiss Re
How To 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 Swiss Re is:
20% = US$3.2b ÷ US$16b (Based on the trailing twelve months to December 2023).
The 'return' is the yearly profit. That means that for every CHF1 worth of shareholders' equity, the company generated CHF0.20 in profit.
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.
Swiss Re's Earnings Growth And 20% ROE
To begin with, Swiss Re seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 16%. This certainly adds some context to Swiss Re's exceptional 45% net income growth seen over the past five years. We reckon that there could also be other factors at play here. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.
As a next step, we compared Swiss Re's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 4.5%.
Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 Swiss Re is trading on a high P/E or a low P/E, relative to its industry.
Is Swiss Re Using Its Retained Earnings Effectively?
Swiss Re has very a high three-year median payout ratio of 139% suggesting that the company's shareholders are getting paid from more than just the company's earnings. Despite this, the company's earnings grew significantly as we saw above. Having said that, the high payout ratio is definitely risky and something to keep an eye on.
Moreover, Swiss Re is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 54% over the next three years. Regardless, the ROE is not expected to change much for the company despite the lower expected payout ratio.
Conclusion
On the whole, we do feel that Swiss Re has some positive attributes. Namely, its high earnings growth, which was likely due to its high ROE. However, investors could have benefitted even more from the high ROE, had the company been reinvesting more of its earnings. As discussed earlier, the company is retaining hardly any of its profits. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.
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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.
