Most readers would already know that Brown & Brown's (NYSE:BRO) stock increased by 4.8% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Specifically, we decided to study Brown & Brown's ROE in this article.

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

How Do You 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 Brown & Brown is:

16% = US$1.1b ÷ US$6.5b (Based on the trailing twelve months to September 2024).

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 $0.16 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. 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. 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.

Brown & Brown's Earnings Growth And 16% ROE

At first glance, Brown & Brown seems to have a decent ROE. Even when compared to the industry average of 14% the company's ROE looks quite decent. Consequently, this likely laid the ground for the decent growth of 18% seen over the past five years by Brown & Brown.

We then compared Brown & Brown's 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 11% in the same 5-year period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. Is Brown & Brown fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Brown & Brown Using Its Retained Earnings Effectively?

In Brown & Brown's case, its respectable earnings growth can probably be explained by its low three-year median payout ratio of 18% (or a retention ratio of 82%), which suggests that the company is investing most of its profits to grow its business.

Besides, Brown & Brown has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 15% of its profits over the next three years. Accordingly, forecasts suggest that Brown & Brown's future ROE will be 18% which is again, similar to the current ROE.

Summary

Overall, we are quite pleased with Brown & Brown's performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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.