Insurance Australia Group (ASX:IAG) has had a rough three months with its share price down 9.9%. However, stock prices are usually driven by a company's financial performance over the long term, which in this case looks quite promising. In this article, we decided to focus on Insurance Australia 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 the capital provided by the company's shareholders.
How To Calculate Return On Equity?
ROE 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 Insurance Australia Group is:
20% = AU$1.5b ÷ AU$7.8b (Based on the trailing twelve months to June 2025).
The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$0.20 in profit.
See our latest analysis for Insurance Australia Group
What Is The Relationship Between ROE And Earnings Growth?
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.
Insurance Australia Group's Earnings Growth And 20% ROE
At first glance, Insurance Australia Group seems to have a decent ROE. Especially when compared to the industry average of 15% the company's ROE looks pretty impressive. This probably laid the ground for Insurance Australia Group's significant 49% net income growth seen over the past five years. However, there could also be other causes behind this growth. For instance, the company has a low payout ratio or is being managed efficiently.
Next, on comparing with the industry net income growth, we found that Insurance Australia Group's growth is quite high when compared to the industry average growth of 19% in the same period, which is great to see.
Earnings growth is a huge factor in stock valuation. It's important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Has the market priced in the future outlook for IAG? You can find out in our latest intrinsic value infographic research report.
Is Insurance Australia Group Making Efficient Use Of Its Profits?
The high three-year median payout ratio of 54% (implying that it keeps only 46% of profits) for Insurance Australia Group suggests that the company's growth wasn't really hampered despite it returning most of the earnings to its shareholders.
Additionally, Insurance Australia 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. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 72% over the next three years. Consequently, the higher expected payout ratio explains the decline in the company's expected ROE (to 15%) over the same period.
Summary
Overall, we are quite pleased with Insurance Australia Group's performance. In particular, its high ROE is quite noteworthy and also the probable explanation behind its considerable earnings growth. Yet, the company is retaining a small portion of its profits. Which means that the company has been able to grow its earnings in spite of it, so that's not too bad. 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. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.
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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.
