Are Robust Financials Driving The Recent Rally In Arthur J. Gallagher & Co.'s (NYSE:AJG) Stock?

Unlock stock picks and a broker-level newsfeed that powers Wall Street.

Simply Wall St

Sun, Jan 2, 2022, 4:18 AM 3 min read

Most readers would already be aware that Arthur J. Gallagher's (NYSE:AJG) stock increased significantly by 11% over the past three months. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. Specifically, we decided to study Arthur J. Gallagher's ROE in this article.

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 Arthur J. Gallagher

How To Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Arthur J. Gallagher is:

12% = US$987m ÷ US$8.5b (Based on the trailing twelve months to September 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?

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

Arthur J. Gallagher's Earnings Growth And 12% ROE

To begin with, Arthur J. Gallagher seems to have a respectable ROE. Further, the company's ROE is similar to the industry average of 11%. Consequently, this likely laid the ground for the decent growth of 15% seen over the past five years by Arthur J. Gallagher.

As a next step, we compared Arthur J. Gallagher's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 12%.

past-earnings-growth — NYSE:AJG Past Earnings Growth January 2nd 2022

Earnings growth is an important metric to consider when valuing a stock. 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. What is AJG worth today? The intrinsic value infographic in our free research report helps visualize whether AJG is currently mispriced by the market.

Is Arthur J. Gallagher Making Efficient Use Of Its Profits?

Arthur J. Gallagher has a three-year median payout ratio of 45%, which implies that it retains the remaining 55% of its profits. This suggests that its dividend is well covered, and given the decent growth seen by the company, it looks like management is reinvesting its earnings efficiently.

Besides, Arthur J. Gallagher has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 31% over the next three years. As a result, the expected drop in Arthur J. Gallagher's payout ratio explains the anticipated rise in the company's future ROE to 15%, over the same period.

Summary

In total, we are pretty happy with Arthur J. Gallagher's performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.