Palomar Holdings (NASDAQ:PLMR) has had a great run on the share market with its stock up by a significant 70% over the last three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Particularly, we will be paying attention to Palomar Holdings’ ROE today.
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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.
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 Palomar Holdings is:
14% = US$37m ÷ US$261m (Based on the trailing twelve months to March 2020).
The ‘return’ is the profit over the last twelve months. That means that for every $1 worth of shareholders’ equity, the company generated $0.14 in profit.
What Has ROE Got To Do With Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company’s future earnings. 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.
Palomar Holdings’ Earnings Growth And 14% ROE
To start with, Palomar Holdings’ ROE looks acceptable. Further, the company’s ROE compares quite favorably to the industry average of 8.2%. This probably laid the ground for Palomar Holdings’ significant 39% net income growth seen over the past five years. We believe that there might also be other aspects that are positively influencing the company’s earnings growth. Such as – high earnings retention or an efficient management in place.
We then compared Palomar Holdings’ net income growth with the industry and we’re pleased to see that the company’s growth figure is higher when compared with the industry which has a growth rate of 7.3% in the same period.
Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Palomar Holdings is trading on a high P/E or a low P/E, relative to its industry.
Is Palomar Holdings Making Efficient Use Of Its Profits?
Palomar Holdings doesn’t pay any dividend currently which essentially means that it has been reinvesting all of its profits into the business. This definitely contributes to the high earnings growth number that we discussed above.
On the whole, we feel that Palomar Holdings’ performance has been quite good. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. Having said that, the company’s earnings growth is expected to slow down, as forecasted in the current analyst estimates. Are these analysts expectations based on the broad expectations for the industry, or on the company’s fundamentals? Click here to be taken to our analyst’s forecasts page for the company.
This article by Simply Wall St is general in nature. 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.