I am writing today to help inform people who are new to the stock market and want to begin learning the link between Alliance Resource Partners LP (NASDAQ:ARLP)’s return fundamentals and stock market performance.
Alliance Resource Partners LP (NASDAQ:ARLP) outperformed the Coal and Consumable Fuels industry on the basis of its ROE – producing a higher 28.62% relative to the peer average of 11.36% over the past 12 months. While the impressive ratio tells us that ARLP has made significant profits from little equity capital, ROE doesn’t tell us if ARLP has borrowed debt to make this happen. Today, we’ll take a closer look at some factors like financial leverage to see how sustainable ARLP’s ROE is. View out our latest analysis for Alliance Resource Partners
Peeling the layers of ROE – trisecting a company’s profitability
Return on Equity (ROE) weighs Alliance Resource Partners’s profit against the level of its shareholders’ equity. For example, if the company invests $1 in the form of equity, it will generate $0.29 in earnings from this. In most cases, a higher ROE is preferred; however, there are many other factors we must consider prior to making any investment decisions.
Return on Equity = Net Profit ÷ Shareholders Equity
ROE is measured against cost of equity in order to determine the efficiency of Alliance Resource Partners’s equity capital deployed. Its cost of equity is 9.16%. This means Alliance Resource Partners returns enough to cover its own cost of equity, with a buffer of 19.47%. This sustainable practice implies that the company pays less for its capital than what it generates in return. ROE can be split up into three useful ratios: net profit margin, asset turnover, and financial leverage. This is called the Dupont Formula:
ROE = profit margin × asset turnover × financial leverage
ROE = (annual net profit ÷ sales) × (sales ÷ assets) × (assets ÷ shareholders’ equity)
ROE = annual net profit ÷ shareholders’ equity
Essentially, profit margin shows how much money the company makes after paying for all its expenses. Asset turnover shows how much revenue Alliance Resource Partners can generate with its current asset base. And finally, financial leverage is simply how much of assets are funded by equity, which exhibits how sustainable the company’s capital structure is. Since financial leverage can artificially inflate ROE, we need to look at how much debt Alliance Resource Partners currently has. At 40.80%, Alliance Resource Partners’s debt-to-equity ratio appears low and indicates the above-average ROE is generated from its capacity to increase profit without a large debt burden.
ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. Alliance Resource Partners exhibits a strong ROE against its peers, as well as sufficient returns to cover its cost of equity. ROE is not likely to be inflated by excessive debt funding, giving shareholders more conviction in the sustainability of high returns. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.
For Alliance Resource Partners, I’ve put together three important factors you should further examine:
- Financial Health: Does it have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
- Valuation: What is Alliance Resource Partners worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether Alliance Resource Partners is currently mispriced by the market.
- Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Alliance Resource Partners? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!
To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned.