Yahoo Finance Is Direct Line Insurance Group plc's (LON:DLG) Recent Stock Performance Influenced By Its Financials In Any Way?
Most readers would already know that Direct Line Insurance Group's (LON:DLG) stock increased by 7.3% over the past 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. Specifically, we decided to study Direct Line Insurance Group's ROE in this article.
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
View our latest analysis for Direct Line Insurance Group
How Is ROE Calculated?
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 Direct Line Insurance Group is:
12% = UK£367m ÷ UK£3.0b (Based on the trailing twelve months to December 2020).
The 'return' is the profit over the last twelve months. Another way to think of that is that for every £1 worth of equity, the company was able to earn £0.12 in profit.
What Has ROE Got To Do With Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.
Direct Line Insurance Group's Earnings Growth And 12% ROE
At first glance, Direct Line Insurance Group seems to have a decent ROE. Even when compared to the industry average of 11% the company's ROE looks quite decent. Despite the moderate return on equity, Direct Line Insurance Group has posted a net income growth of 2.6% over the past five years. A few likely reasons that could be keeping earnings growth low are - the company has a high payout ratio or the business has allocated capital poorly, for instance.
Next, on comparing with the industry net income growth, we found that Direct Line Insurance Group's reported growth was lower than the industry growth of 12% in the same period, which is not something we like to see.
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 DLG fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is Direct Line Insurance Group Efficiently Re-investing Its Profits?
The high three-year median payout ratio of 64% (that is, the company retains only 36% of its income) over the past three years for Direct Line Insurance Group suggests that the company's earnings growth was lower as a result of paying out a majority of its earnings.
Moreover, Direct Line Insurance Group has been paying dividends for eight years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 78% over the next three years. Still, forecasts suggest that Direct Line Insurance Group's future ROE will rise to 19% even though the the company's payout ratio is expected to rise. We presume that there could some other characteristics of the business that could be driving the anticipated growth in the company's ROE.
Conclusion
In total, it does look like Direct Line Insurance Group has some positive aspects to its business. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE. Bear in mind, the company reinvests a small portion of its profits, which means that investors aren't reaping the benefits of the high rate of return. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.
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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