Will Beacon Roofing Supply Inc (NASDAQ:BECN) Continue To Underperform Its Industry?
This article is intended for those of you who are at the beginning of your investing journey and want a simplistic look at the return on Beacon Roofing Supply Inc (NASDAQ:BECN) stock.
Beacon Roofing Supply Inc (NASDAQ:BECN) generated a below-average return on equity of 4.16% in the past 12 months, while its industry returned 12.39%. BECN’s results could indicate a relatively inefficient operation to its peers, and while this may be the case, it is important to understand what ROE is made up of and how it should be interpreted. Knowing these components could change your view on BECN’s performance. Today I will look at how components such as financial leverage can influence ROE which may impact the sustainability of BECN’s returns. See our latest analysis for Beacon Roofing Supply
Peeling the layers of ROE – trisecting a company’s profitability
Return on Equity (ROE) weighs Beacon Roofing Supply’s profit against the level of its shareholders’ equity. An ROE of 4.16% implies $0.042 returned on every $1 invested. Generally speaking, a higher ROE is preferred; however, there are other factors we must also consider before making any conclusions.
Return on Equity = Net Profit ÷ Shareholders Equity
Returns are usually compared to costs to measure the efficiency of capital. Beacon Roofing Supply’s cost of equity is 10.73%. This means Beacon Roofing Supply’s returns actually do not cover its own cost of equity, with a discrepancy of -6.57%. This isn’t sustainable as it implies, very simply, that the company pays more for its capital than what it generates in return. ROE can be broken down into three different ratios: net profit margin, asset turnover, and financial leverage. This is called the Dupont Formula:
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 Beacon Roofing Supply can generate with its current asset base. Finally, financial leverage will be our main focus today. It shows how much of assets are funded by equity and can show how sustainable the company’s capital structure is. Since ROE can be inflated by excessive debt, we need to examine Beacon Roofing Supply’s debt-to-equity level. Currently the debt-to-equity ratio stands at a balanced 135.44%, which means its ROE is driven by its ability to grow its profit without a significant debt burden.
Next Steps:
While ROE is a relatively simple calculation, it can be broken down into different ratios, each telling a different story about the strengths and weaknesses of a company. Beacon Roofing Supply’s ROE is underwhelming relative to the industry average, and its returns were also not strong enough to cover its own cost of equity. Although, its appropriate level of leverage means investors can be more confident in the sustainability of Beacon Roofing Supply’s return with a possible increase should the company decide to increase its debt levels. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.
For Beacon Roofing Supply, I’ve compiled three essential aspects you should further research:
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 Beacon Roofing Supply 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 Beacon Roofing Supply is currently mispriced by the market.
Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Beacon Roofing Supply? 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.
