Shares of Safety Insurance Group (NASDAQ:SAFT) have gained 7.1% over the past three months. Given that 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 increasing its value and managing investors’ money. In other words, it is a profitability ratio that measures the rate of return on the capital provided by the company’s shareholders.
Check out our latest analysis on Safety Insurance Group
How do you calculate return on equity?
ROE can be calculated using the formula:
Return on equity = Net income (from continuing operations) ÷ Equity
So, based on the above formula, the ROE for Safety Insurance Group is:
2.3% = US$19 million ÷ US$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 shareholders’ equity, the company generates $0.02 in profit.
What does ROE have to do with revenue growth?
We have already established that ROE serves as an effective 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 assess the company’s earnings growth potential. Generally speaking, other things being equal, firms with a high return on capital and earnings retention have a higher growth rate than firms that do not share these characteristics.
Safety Insurance Group earnings growth and 2.3% ROE
As you can see, Safety Insurance Group’s ROE looks pretty weak. Even compared to the industry average ROE of 13%, the company’s ROE is pretty dismal. Therefore, it may not be wrong to say that the 16% five-year decline in net income seen by Safety Insurance Group is probably a result of it having a lower ROE. However, there may be other factors causing the 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 cutting earnings, the industry has been growing at a rate of 7.8% over the past few years.
The basis for valuing a company is largely related to its revenue growth. It is important for the investor to know whether the market has priced in the expected growth (or decline) of the company’s earnings. This will help them determine whether the future of the stock looks promising or ominous. Is the market pricing in future prospects for SAFT? You can find out in our latest Intrinsic Value Infographic Research Report
Is Safety Insurance Group using its profits effectively?
With a high three-year average payout ratio of 72% (meaning 28% of earnings are retained), the majority of Safety Insurance Group’s earnings are paid out to shareholders, which explains the company’s declining earnings. With only little reinvestment in the business, earnings growth will obviously be low or non-existent. To learn the 3 risks we identified for Safety Insurance Group, visit our risk dashboard for free.
Additionally, Safety Insurance Group has paid dividends for at least ten years, suggesting that maintaining dividend payments is much more important to management, even if it comes at the expense of business growth.
Summary
Overall, we would think carefully before deciding on any investment action regarding Safety Insurance Group. Since the company is not reinvesting much in the business and given the low return on capital, 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 own research on Safety Insurance Group and see how it has performed in the past by checking out this FREE detailed graphics of past earnings, revenue and cash flows.
Have feedback on this article? Concerned about content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
This article from Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts, using only an unbiased methodology, and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. We aim to provide you with long-term focused analysis driven by fundamental data. Note that our analysis may not take into account the latest price-sensitive company announcements or quality materials. Simply Wall St has no position in the stocks mentioned.