Most readers would already know that RLI's (NYSE:RLI) stock increased by 3.4% over the past three months. Given its impressive performance, we decided to study the company's key financial indicators as a company's long-term fundamentals usually dictate market outcomes. In this article, we decided to focus on RLI's ROE.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's 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 RLI is:
53% = US$714m ÷ US$1.4b (Based on the trailing twelve months to June 2023).
The 'return' is the profit over the last twelve months. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.53.
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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.
Firstly, we acknowledge that RLI has a significantly high ROE. Second, a comparison with the average ROE reported by the industry of 11% also doesn't go unnoticed by us. So, the substantial 41% net income growth seen by RLI over the past five years isn't overly surprising.
We then compared RLI'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 11% in the same 5-year period.
Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about RLI's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
RLI has a really low three-year median payout ratio of 16%, meaning that it has the remaining 84% left over to reinvest into its business. So it seems like the management is reinvesting profits heavily to grow its business and this reflects in its earnings growth number.
Moreover, RLI 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. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 40% over the next three years. Consequently, the higher expected payout ratio explains the decline in the company's expected ROE (to 16%) over the same period.
On the whole, we feel that RLI's performance has been quite good. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. With that said, on studying the latest analyst forecasts, we found that while the company has seen growth in its past earnings, analysts expect its future earnings to shrink. 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.
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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.