Donegal Group Inc.'s (NASDAQ:DGIC.A) Has Been On A Rise But Financial Prospects Look Weak: Is The Stock Overpriced?

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editorial-team@simplywallst.com (Simply Wall St)

Thu, Nov 21, 2024, 3:15 AM 4 min read

Donegal Group (NASDAQ:DGIC.A) has had a great run on the share market with its stock up by a significant 8.9% over the last month. However, we decided to pay close attention to its weak financials as we are doubtful that the current momentum will keep up, given the scenario. Particularly, we will be paying attention to Donegal Group's ROE today.

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.

See our latest analysis for Donegal Group

How Is ROE Calculated?

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 Donegal Group is:

4.8% = US$25m ÷ US$513m (Based on the trailing twelve months to September 2024).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.05 in profit.

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. 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.

Donegal Group's Earnings Growth And 4.8% ROE

At first glance, Donegal Group's ROE doesn't look very promising. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 14%. For this reason, Donegal Group's five year net income decline of 39% is not surprising given its lower ROE. However, there could also be other factors causing the earnings to decline. Such as - low earnings retention or poor allocation of capital.

So, as a next step, we compared Donegal Group's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 13% over the last few years.

past-earnings-growth — NasdaqGS:DGIC.A Past Earnings Growth November 21st 2024

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). This then helps them determine if the stock is placed for a bright or bleak future. Is Donegal Group fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Donegal Group Efficiently Re-investing Its Profits?

Donegal Group's declining earnings is not surprising given how the company is spending most of its profits in paying dividends, judging by its three-year median payout ratio of 92% (or a retention ratio of 8.0%). With only very little left to reinvest into the business, growth in earnings is far from likely.

In addition, Donegal Group has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 59% over the next three years. As a result, the expected drop in Donegal Group's payout ratio explains the anticipated rise in the company's future ROE to 7.2%, over the same period.

Conclusion

Overall, we would be extremely cautious before making any decision on Donegal Group. Particularly, its ROE is a huge disappointment, not to mention its lack of proper reinvestment into the business. As a result its earnings growth has also been quite disappointing. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.