It is hard to get excited after looking at Selective Insurance Group's (NASDAQ:SIGI) recent performance, when its stock has declined 7.4% over the past month. It seems that the market might have completely ignored the positive aspects of the company's fundamentals and decided to weigh-in more on the negative aspects. Stock prices are usually driven by a company’s financial performance over the long term, and therefore we decided to pay more attention to the company's financial performance. Specifically, we decided to study Selective Insurance Group'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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

Check out our latest analysis for Selective 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 Selective Insurance Group is:

7.5% = US$236m ÷ US$3.2b (Based on the trailing twelve months to September 2024).

The 'return' is the yearly profit. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.07 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 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.

Selective Insurance Group's Earnings Growth And 7.5% ROE

On the face of it, Selective Insurance Group's ROE is not much to talk about. Next, when compared to the average industry ROE of 14%, the company's ROE leaves us feeling even less enthusiastic. As a result, Selective Insurance Group's flat net income growth over the past five years doesn't come as a surprise given its lower ROE.

As a next step, we compared Selective Insurance Group's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 13% in the same period.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Selective Insurance Group's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Selective Insurance Group Efficiently Re-investing Its Profits?

Despite having a moderate three-year median payout ratio of 25% (meaning the company retains75% of profits) in the last three-year period, Selective Insurance Group's earnings growth was more or les flat. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Additionally, Selective Insurance Group 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. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 19% over the next three years. As a result, the expected drop in Selective Insurance Group's payout ratio explains the anticipated rise in the company's future ROE to 15%, over the same period.

Summary

In total, we're a bit ambivalent about Selective Insurance Group's performance. 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 analyst forecasts show that the company will continue to see an expansion in its earnings. 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.

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.