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Is Weakness In Humana Inc. (NYSE:HUM) Stock A Sign That The Market Could be Wrong Given Its Strong Financial Prospects?

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With its stock down 4.7% over the past month, it is easy to disregard Humana (NYSE:HUM). However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. In this article, we decided to focus on Humana'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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Humana

How Is ROE Calculated?

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 Humana is:

20% = US$3.0b ÷ US$15b (Based on the trailing twelve months to March 2022).

The 'return' is the yearly profit. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.20 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

A Side By Side comparison of Humana's Earnings Growth And 20% ROE

At first glance, Humana seems to have a decent ROE. On comparing with the average industry ROE of 15% the company's ROE looks pretty remarkable. This probably laid the ground for Humana's moderate 15% net income growth seen over the past five years.

Next, on comparing Humana's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 18% in the same period.

past-earnings-growth
past-earnings-growth

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. This then helps them determine if the stock is placed for a bright or bleak future. Is Humana fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Humana Efficiently Re-investing Its Profits?

Humana's three-year median payout ratio to shareholders is 11% (implying that it retains 89% of its income), which is on the lower side, so it seems like the management is reinvesting profits heavily to grow its business.

Additionally, Humana has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 15% over the next three years. Despite the higher expected payout ratio, the company's ROE is not expected to change by much.

Summary

In total, we are pretty happy with Humana's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. 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 company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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

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.