Will Cheetah Mobile Inc (CMCM) Continue To Underperform Its Industry?
Cheetah Mobile Inc’s (NYSE:CMCM) most recent return on equity was a substandard 7.25% relative to its industry performance of 12.86% over the past year. Though CMCM’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 CMCM’s below-average returns. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of CMCM’s returns. Let me show you what I mean by this. Check out our latest analysis for Cheetah Mobile
What you must know about ROE
Return on Equity (ROE) weighs CMCM’s profit against the level of its shareholders’ equity. For example, if CMCM invests $1 in the form of equity, it will generate $0.07 in earnings from this. 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. CMCM’s cost of equity is 9.87%. Since CMCM’s return does not cover its cost, with a difference of -2.62%, this means its current use of equity is not efficient and not sustainable. Very simply, CMCM pays more 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:
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 CMCM 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 CMCM’s capital structure is. Since ROE can be artificially increased through excessive borrowing, we should check CMCM’s historic debt-to-equity ratio. The debt-to-equity ratio currently stands at a low 12.93%, meaning CMCM still has headroom to borrow debt to increase profits.
What this means for you:
Are you a shareholder? CMCM’s ROE is underwhelming relative to the industry average, and its returns were also not strong enough to cover its own cost of equity. Since its existing ROE is not fuelled by unsustainable debt, investors shouldn’t give up as CMCM still has capacity to improve shareholder returns by borrowing to invest in new projects in the future. If you’re looking for new ideas for high-returning stocks, you should take a look at our free platform to see the list of stocks with Return on Equity over 20%.
Are you a potential investor? If you are considering investing in CMCM, basing your decision on ROE alone is certainly not sufficient. I recommend you do additional fundamental analysis by looking through our most recent infographic report on Cheetah Mobile to help you make a more informed investment decision.
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.
