Central Garden & Pet Company (NASDAQ:CENT): Can It Deliver A Superior ROE To The Industry?
This analysis is intended to introduce important early concepts to people who are starting to invest and want to better understand how you can grow your money by investing in Central Garden & Pet Company (NASDAQ:CENT).
Central Garden & Pet Company’s (NASDAQ:CENT) most recent return on equity was a substandard 15.45% relative to its industry performance of 15.67% over the past year. Though CENT’s recent performance is underwhelming, it is useful to understand what ROE is made up of and how it should be interpreted. Knowing these components can change your views on CENT’s below-average returns. I will take you through how metrics such as financial leverage impact ROE which may affect the overall sustainability of CENT’s returns. View out our latest analysis for Central Garden & Pet
Peeling the layers of ROE – trisecting a company’s profitability
Return on Equity (ROE) is a measure of Central Garden & Pet’s profit relative to its shareholders’ equity. An ROE of 15.45% implies $0.15 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
ROE is measured against cost of equity in order to determine the efficiency of Central Garden & Pet’s equity capital deployed. Its cost of equity is 8.59%. Some of Central Garden & Pet’s peers may have a higher ROE but its cost of equity could exceed this return, leading to an unsustainable negative discrepancy i.e. the company spends more than it earns. This is not the case for Central Garden & Pet which is reassuring. ROE can be dissected into three distinct 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
The first component is profit margin, which measures how much of sales is retained after the company pays for all its expenses. Asset turnover shows how much revenue Central Garden & Pet 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 Central Garden & Pet’s debt-to-equity level. At 98.02%, Central Garden & Pet’s debt-to-equity ratio appears balanced and indicates its ROE is generated from its capacity to increase profit without a large debt burden.
Next Steps:
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. Even though Central Garden & Pet returned below the industry average, its ROE comes in excess of its cost of equity. Its appropriate level of leverage means investors can be more confident in the sustainability of Central Garden & Pet’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 Central Garden & Pet, I’ve compiled three key factors 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 Central Garden & Pet 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 Central Garden & Pet is currently mispriced by the market.
Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Central Garden & Pet? 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.
