It is hard to get excited after looking at Arthur J. Gallagher's (NYSE:AJG) recent performance, when its stock has declined 6.4% over the past month. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Particularly, we will be paying attention to Arthur J. Gallagher's ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for Arthur J. Gallagher

How Is ROE Calculated?

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$1.1b ÷ US$8.9b (Based on the trailing twelve months to June 2022).

The 'return' is the yearly profit. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.12.

What Is The Relationship Between ROE And 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 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.

A Side By Side comparison of Arthur J. Gallagher's Earnings Growth And 12% ROE

At first glance, Arthur J. Gallagher seems to have a decent ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 11%. Consequently, this likely laid the ground for the decent growth of 14% seen over the past five years by Arthur J. Gallagher.

Next, on comparing Arthur J. Gallagher's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 14% 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. Has the market priced in the future outlook for AJG? You can find out in our latest intrinsic value infographic research report.

Is Arthur J. Gallagher Using Its Retained Earnings Effectively?

With a three-year median payout ratio of 43% (implying that the company retains 57% of its profits), it seems that Arthur J. Gallagher is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.

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 24% 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 19%, over the same period.

Summary

Overall, we are quite pleased 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.

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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.