How The Cheesecake Factory Incorporated (NASDAQ:CAKE) Delivered A Better ROE Than Its 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 The Cheesecake Factory Incorporated (NASDAQ:CAKE).
The Cheesecake Factory Incorporated (NASDAQ:CAKE) delivered an ROE of 24.97% over the past 12 months, which is an impressive feat relative to its industry average of 13.67% during the same period. On the surface, this looks fantastic since we know that CAKE 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 CAKE’s ROE is. See our latest analysis for Cheesecake Factory
What you must know about ROE
Return on Equity (ROE) weighs Cheesecake Factory’s profit against the level of its shareholders’ equity. An ROE of 24.97% implies $0.25 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 assessed against cost of equity, which is measured using the Capital Asset Pricing Model (CAPM) – but let’s not dive into the details of that today. For now, let’s just look at the cost of equity number for Cheesecake Factory, which is 9.82%. Given a positive discrepancy of 15.15% between return and cost, this indicates that Cheesecake Factory pays less for its capital than what it generates in return, which is a sign of capital efficiency. ROE can be split up into three useful 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 reveals how much revenue can be generated from Cheesecake Factory’s 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 Cheesecake Factory currently has. At 24.05%, Cheesecake Factory’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.
Next Steps:
ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. Cheesecake Factory 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. Although ROE can be a useful metric, it is only a small part of diligent research.
For Cheesecake Factory, I’ve put together three important 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 Cheesecake Factory 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 Cheesecake Factory is currently mispriced by the market.
Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Cheesecake Factory? 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.
