CommScope Holding Company Inc (NASDAQ:COMM) delivered an ROE of 12.55% over the past 12 months, which is an impressive feat relative to its industry average of 6.35% during the same period. Superficially, this looks great since we know that COMM has generated big profits with little equity capital; however, ROE doesn’t tell us how much COMM has borrowed in debt. Today, we’ll take a closer look at some factors like financial leverage to see how sustainable COMM’s ROE is. See our latest analysis for CommScope Holding Company
Breaking down Return on Equity
Return on Equity (ROE) weighs CommScope Holding Company’s profit against the level of its shareholders’ equity. For example, if the company invests $1 in the form of equity, it will generate $0.13 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
ROE is measured against cost of equity in order to determine the efficiency of CommScope Holding Company’s equity capital deployed. Its cost of equity is 12.53%. This means CommScope Holding Company returns enough to cover its own cost of equity, with a buffer of 0.02%. This sustainable practice implies that the company 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 reveals how much revenue can be generated from CommScope Holding Company’s asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. Since ROE can be artificially increased through excessive borrowing, we should check CommScope Holding Company’s historic debt-to-equity ratio. Currently the debt-to-equity ratio stands at more than 2.5 times, which means its above-average ROE is driven by significant debt levels.
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. CommScope Holding Company’s ROE is impressive relative to the industry average and also covers 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 CommScope Holding Company’s returns. Although ROE can be a useful metric, it is only a small part of diligent research.
For CommScope Holding Company, I’ve compiled three pertinent aspects you should further examine:
- 1. 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.
- 2. Valuation: What is CommScope Holding Company 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 CommScope Holding Company is currently mispriced by the market.
- 3. Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of CommScope Holding Company? 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.