EastGroup Properties Inc (NYSE:EGP) delivered an ROE of 11.13% over the past 12 months, which is an impressive feat relative to its industry average of 7.37% during the same period. On the surface, this looks fantastic since we know that EGP has made large profits from little equity capital; however, ROE doesn’t tell us if management have borrowed heavily to make this happen. Today, we’ll take a closer look at some factors like financial leverage to see how sustainable EGP’s ROE is. See our latest analysis for EastGroup Properties
Peeling the layers of ROE – trisecting a company’s profitability
Firstly, Return on Equity, or ROE, is simply the percentage of last years’ earning against the book value of shareholders’ equity. For example, if the company invests $1 in the form of equity, it will generate $0.11 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 EastGroup Properties’s equity capital deployed. Its cost of equity is 8.49%. Since EastGroup Properties’s return covers its cost in excess of 2.63%, its use of equity capital is efficient and likely to be sustainable. Simply put, EastGroup Properties 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
Basically, profit margin measures how much of revenue trickles down into earnings which illustrates how efficient the business is with its cost management. Asset turnover shows how much revenue EastGroup Properties can generate with its current asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. Since ROE can be inflated by excessive debt, we need to examine EastGroup Properties’s debt-to-equity level. At 150.42%, EastGroup Properties’s debt-to-equity ratio appears relatively high and indicates the above-average ROE is generated by significant leverage levels.
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. EastGroup Properties’s above-industry ROE is encouraging, and is also in excess of its cost of equity. Its high debt level means its strong ROE may be driven by debt funding which raises concerns over the sustainability of EastGroup Properties’s returns. Although ROE can be a useful metric, it is only a small part of diligent research.
For EastGroup Properties, I’ve put together three pertinent aspects you should look at:
- 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 EastGroup Properties 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 EastGroup Properties is currently mispriced by the market.
- Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of EastGroup Properties? 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.