Most readers would already know that Aflac's (NYSE:AFL) stock increased by 5.9% over the past three months. Given its impressive performance, we decided to study the company's key financial indicators as a company's long-term fundamentals usually dictate market outcomes. In this article, we decided to focus on Aflac's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

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 Aflac is:

21% = US$5.4b ÷ US$26b (Based on the trailing twelve months to December 2024).

The 'return' is the yearly profit. That means that for every $1 worth of shareholders' equity, the company generated $0.21 in profit.

View our latest analysis for Aflac

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.

Aflac's Earnings Growth And 21% ROE

At first glance, Aflac seems to have a decent ROE. Especially when compared to the industry average of 15% the company's ROE looks pretty impressive. This probably laid the ground for Aflac's moderate 5.5% net income growth seen over the past five years.

We then compared Aflac's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 12% in the same 5-year period, which is a bit concerning.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. What is AFL worth today? The intrinsic value infographic in our free research report helps visualize whether AFL is currently mispriced by the market.

Is Aflac Using Its Retained Earnings Effectively?

Aflac has a low three-year median payout ratio of 21%, meaning that the company retains the remaining 79% of its profits. This suggests that the management is reinvesting most of the profits to grow the business.

Besides, Aflac 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 rise to 32% over the next three years. Therefore, the expected rise in the payout ratio explains why the company's ROE is expected to decline to 14% over the same period.

Conclusion

In total, we are pretty happy with Aflac's performance. 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 a good amount of growth in its earnings. Having said that, on studying current analyst estimates, we were concerned to see that while the company has grown its earnings in the past, analysts expect its earnings to shrink in the future. 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.