Prudential plc's (LON:PRU) Stock Is Rallying But Financials Look Ambiguous: Will The Momentum Continue?

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

Wed, Feb 5, 2025, 2:37 AM 4 min read

Prudential (LON:PRU) has had a great run on the share market with its stock up by a significant 6.9% over the last month. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. In this article, we decided to focus on Prudential's ROE.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for Prudential

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 Prudential is:

5.5% = US$947m ÷ US$17b (Based on the trailing twelve months to June 2024).

The 'return' is the yearly profit. That means that for every £1 worth of shareholders' equity, the company generated £0.05 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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.

Prudential's Earnings Growth And 5.5% ROE

At first glance, Prudential'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%. Therefore, it might not be wrong to say that the five year net income decline of 21% seen by Prudential was probably the result of it having a lower ROE. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

From the 21% decline reported by the industry in the same period, we infer that Prudential and its industry are both shrinking at a similar rate.

past-earnings-growth — LSE:PRU Past Earnings Growth February 5th 2025

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Prudential fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Prudential Efficiently Re-investing Its Profits?

Looking at its three-year median payout ratio of 33% (or a retention ratio of 67%) which is pretty normal, Prudential's declining earnings is rather baffling as one would expect to see a fair bit of growth when a company is retaining a good portion of its profits. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.

Additionally, Prudential has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 27% of its profits over the next three years. Still, forecasts suggest that Prudential's future ROE will rise to 13% even though the the company's payout ratio is not expected to change by much.

Summary

On the whole, we feel that the performance shown by Prudential can be open to many interpretations. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. 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.