American Financial Group (NYSE:AFG) has had a great run on the share market with its stock up by a significant 34% over the last three months. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. Particularly, we will be paying attention to American Financial Group's ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for American Financial Group

How Do You Calculate Return On Equity?

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 American Financial Group is:

11% = US$721m ÷ US$6.8b (Based on the trailing twelve months to December 2020).

The 'return' is the yearly profit. That means that for every $1 worth of shareholders' equity, the company generated $0.11 in profit.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. 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.

American Financial Group's Earnings Growth And 11% ROE

To start with, American Financial Group's ROE looks acceptable. Even when compared to the industry average of 9.0% the company's ROE looks quite decent. However, we are curious as to how American Financial Group's decent returns still resulted in flat growth for American Financial Group in the past five years. So, there could be some other aspects that could potentially be preventing the company from growing. These include low earnings retention or poor allocation of capital.

We then compared American Financial Group's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 6.2% in the same period, which is a bit concerning.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. Has the market priced in the future outlook for AFG? You can find out in our latest intrinsic value infographic research report.