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With its stock down 17% over the past three months, it is easy to disregard Direct Line Insurance Group (LON:DLG). 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 Direct Line Insurance Group's ROE.
Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Put another way, it reveals the company's success at turning shareholder investments into profits.
View our latest analysis for Direct Line Insurance Group
How To 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 Direct Line Insurance Group is:
12% = UK£344m ÷ UK£2.9b (Based on the trailing twelve months to December 2021).
The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.12 in profit.
Why Is ROE Important For Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.
A Side By Side comparison of Direct Line Insurance Group's Earnings Growth And 12% ROE
To begin with, Direct Line Insurance Group seems to have a respectable ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 12%. However, we are curious as to how Direct Line Insurance Group's decent returns still resulted in flat growth for Direct Line Insurance Group in the past five years. So, there could be some other aspects that could potentially be preventing the company from growing. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.
Next, on comparing with the industry net income growth, we found that the growth figure reported by Direct Line Insurance Group compares quite favourably to the industry average, which shows a decline of 6.1% in the same period.
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. If you're wondering about Direct Line Insurance Group's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.