HDFC Life Insurance Company Limited's (NSE:HDFCLIFE) Stock Has Been Sliding But Fundamentals Look Strong: Is The Market Wrong? – Simply Wall St

With its stock down 14% over the past three months, it is easy to disregard HDFC Life Insurance (NSE:HDFCLIFE). 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 HDFC Life Insurance’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. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company’s shareholders.

View our latest analysis for HDFC Life Insurance

How To 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 HDFC Life Insurance is:

13% = ₹12b ÷ ₹92b (Based on the trailing twelve months to December 2021).

The ‘return’ is the profit over the last twelve months. That means that for every ₹1 worth of shareholders’ equity, the company generated ₹0.13 in profit.

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. Based on how much of its profits the company chooses to reinvest or “retain”, we are then able to evaluate a company’s future ability to generate profits. 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.

HDFC Life Insurance’s Earnings Growth And 13% ROE

On the face of it, HDFC Life Insurance’s ROE is not much to talk about. However, the fact that the company’s ROE is higher than the average industry ROE of 7.0%, is definitely interesting. However, HDFC Life Insurance’s five year net income growth was quite low averaging at only 3.8%. Remember, the company’s ROE is quite low to begin with, just that it is higher than the industry average. Therefore, the low growth in earnings could also be the result of this.

Next, on comparing with the industry net income growth, we found that the growth figure reported by HDFC Life Insurance compares quite favourably to the industry average, which shows a decline of 3.6% in the same period.

NSEI:HDFCLIFE Past Earnings Growth April 10th 2022

Earnings growth is an important metric to consider when valuing a stock. 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. 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 HDFC Life Insurance is trading on a high P/E or a low P/E, relative to its industry.

Is HDFC Life Insurance Efficiently Re-investing Its Profits?

Despite having a moderate three-year median payout ratio of 32% (implying that the company retains the remaining 68% of its income), HDFC Life Insurance’s earnings growth was quite low. So there could be some other explanation in that regard. For instance, the company’s business may be deteriorating.

Additionally, HDFC Life Insurance has paid dividends over a period of four 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 HDFC Life Insurance’s payout ratio explains the anticipated rise in the company’s future ROE to 16%, over the same period.

Conclusion

In total, we are pretty happy with HDFC Life Insurance’s performance. In particular, it’s great to see that the company has seen significant growth in its earnings backed by a respectable ROE and a high reinvestment rate. With that said, the latest industry analyst forecasts reveal that the company’s earnings are expected to accelerate. 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.

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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.