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It is hard to get excited after looking at Arch Capital Group's (NASDAQ:ACGL) recent performance, when its stock has declined 12% over the past three months. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. In this article, we decided to focus on Arch Capital 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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.
View our latest analysis for Arch Capital Group
How Do You Calculate Return On Equity?
The formula for return on equity is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Arch Capital Group is:
26% = US$5.7b ÷ US$22b (Based on the trailing twelve months to September 2024).
The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.26 in profit.
What Is The Relationship Between ROE And 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.
Arch Capital Group's Earnings Growth And 26% ROE
Firstly, we acknowledge that Arch Capital Group has a significantly high ROE. Additionally, the company's ROE is higher compared to the industry average of 14% which is quite remarkable. So, the substantial 31% net income growth seen by Arch Capital Group over the past five years isn't overly surprising.
We then compared Arch Capital Group'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 13% in the same 5-year period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. Is Arch Capital Group fairly valued compared to other companies? These 3 valuation measures might help you decide.