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Most readers would already be aware that White Mountains Insurance Group's (NYSE:WTM) stock increased significantly by 22% over the past month. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. In this article, we decided to focus on White Mountains Insurance Group's ROE.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
How Do You Calculate Return On Equity?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for White Mountains Insurance Group is:
1.8% = US$57m ÷ US$3.1b (Based on the trailing twelve months to June 2020).
The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.02 in profit.
Why Is ROE Important For Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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. 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.
A Side By Side comparison of White Mountains Insurance Group's Earnings Growth And 1.8% ROE
It is quite clear that White Mountains Insurance Group's ROE is rather low. Even when compared to the industry average of 8.1%, the ROE figure is pretty disappointing. However, we we're pleasantly surprised to see that White Mountains Insurance Group grew its net income at a significant rate of 26% in the last five years. Therefore, there could be other reasons behind this growth. Such as - high earnings retention or an efficient management in place.
We then compared White Mountains Insurance Group's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 8.0% in the same period.
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. 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 White Mountains Insurance Group is trading on a high P/E or a low P/E, relative to its industry.
Is White Mountains Insurance Group Using Its Retained Earnings Effectively?
White Mountains Insurance Group has a really low three-year median payout ratio of 0.8%, meaning that it has the remaining 99% left over to reinvest into its business. So it looks like White Mountains Insurance Group is reinvesting profits heavily to grow its business, which shows in its earnings growth.
Additionally, White Mountains Insurance Group 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.
In total, it does look like White Mountains Insurance Group has some positive aspects to its business. Despite its low rate of return, the fact that the company reinvests a very high portion of its profits into its business, no doubt contributed to its high earnings growth. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. You can see the 1 risk we have identified for White Mountains Insurance Group by visiting our risks dashboard for free on our platform here.
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.
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