Should shareholders prepare for a share price correction?

Safety Insurance Group (NASDAQ:SAFT) stock is up 7.1% over the past three months. As the markets usually pay for the long-term financial health of a company, we wonder if the current momentum in the share price will continue, given that the company’s financials do not look very promising. In this article, we decided to focus on Safety Insurance Group’s ROE.

Return on equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on capital provided by the company’s shareholders.

See our recent analysis of Safety Insurance Group

How do you calculate return on equity?

ROE can be calculated using the formula:

Return on equity = Net profit (from continuing operations) ÷ Shareholders’ equity

So, based on the above formula, the ROE for Security Insurance Group is:

2.3% = $19 million ÷ $804 million (Based on trailing twelve months to December 2023).

‘Return’ is the income the business has earned over the past year. This means that for every $1 of shareholder equity, the company generated $0.02 of profit.

What does ROE have to do with earnings growth?

We have already established that ROE serves as an efficient profit-generating measure of a company’s future earnings. Depending on how much of these earnings the company reinvests or “retains” and how effectively it does so, we are able to estimate a company’s earnings growth potential. In general, other things being equal, firms with a high return on equity and earnings retention have a higher growth rate than firms that do not share these attributes.

Safety Insurance Group revenue growth and 2.3% ROE

As you can see, Safety Insurance Group’s ROE looks pretty weak. Even compared to the industry ROE average of 13%, the company’s ROE is quite dismal. Therefore, it may not be wrong to say that the 16% five-year net income decline seen by Safety Insurance Group was probably the result of a lower ROE. However, there may be other factors that cause a decline in profits. For example, the business has allocated capital poorly, or that the company has a very high payout ratio.

So, as a next step, we compared Safety Insurance Group’s performance to the industry and were disappointed to find that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 7.8% over the past few years.

past income-growthpast income-growth

past income-growth

The basis for valuing a company is, to a large extent, tied to its earnings growth. It is important for an investor to know whether the market has priced in the increase (or decrease) in the company’s expected earnings. Doing so will help them determine whether the future of the stock looks promising or ominous. Is the market pricing in the future outlook for SAFT? You can find out in our latest Intrinsic Value Infographic research report

Is Safety Insurance Group using its profits efficiently?

With a high three-year average payout ratio of 72% (meaning 28% of earnings are retained), most of Safety Insurance Group’s earnings are paid out to shareholders, which explains the company’s shrinking earnings. With only a little reinvestment in the business, revenue growth would obviously be low or non-existent. To know the 3 risks we have identified for Safety Insurance Group, visit our free risk dashboard.

In addition, Safety Insurance Group has paid dividends over a period of at least ten years, suggesting that maintaining dividend payments is much more important to management, even if it comes at the cost of growing the business.

Briefing

All in all, we would think long and hard before deciding on any investment action regarding Safety Insurance Group. Because the company is not reinvesting much in the business and given the low ROE, it is not surprising to see little or no growth in its earnings. So far, we have only done a brief survey of the company’s growth data. You can do your research on Safety Insurance Group and see how it has performed in the past by watching this FREE detailed chart of past profits, income and cash flows.

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This article from 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 into account your financial objectives or situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not include the latest price-sensitive company announcements or quality materials. Simply Wall St has no position in any of the stocks mentioned.

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