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Cincinnati Financial's (NASDAQ:CINF) stock is up by a considerable 15% over the past month. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. In this article, we decided to focus on Cincinnati Financial'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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
View our latest analysis for Cincinnati Financial
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 Cincinnati Financial is:
12% = US$1.4b ÷ US$11b (Based on the trailing twelve months to June 2023).
The 'return' refers to a company's earnings over the last year. That means that for every $1 worth of shareholders' equity, the company generated $0.12 in profit.
What Is The Relationship Between ROE And Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.
Cincinnati Financial's Earnings Growth And 12% ROE
To start with, Cincinnati Financial's ROE looks acceptable. Further, the company's ROE is similar to the industry average of 10%. Despite this, Cincinnati Financial's five year net income growth was quite flat over the past five years. We reckon that there could be some other factors at play here that's limiting the company's growth. These include low earnings retention or poor allocation of capital.
We then compared Cincinnati Financial's net income growth with the industry and found that the average industry growth rate was 11% in the same 5-year period.
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). Doing so will help them establish if the stock's future looks promising or ominous. Is Cincinnati Financial fairly valued compared to other companies? These 3 valuation measures might help you decide.