Compagnie Générale des Établissements Michelin (EPA:ML): Can It Deliver A Superior ROE To The Industry?
Compagnie Générale des Établissements Michelin’s (ENXTPA:ML) most recent return on equity was a substandard 15.03% relative to its industry performance of 19.71% over the past year. ML’s results could indicate a relatively inefficient operation to its peers, and while this may be the case, it is important to understand what ROE is made up of and how it should be interpreted. Knowing these components could change your view on ML’s performance. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of ML’s returns. Let me show you what I mean by this. See our latest analysis for Compagnie Générale des Établissements Michelin
Breaking down ROE — the mother of all ratios
Firstly, Return on Equity, or ROE, is simply the percentage of last years’ earning against the book value of shareholders’ equity. An ROE of 15.03% implies €0.15 returned on every €1 invested. While a higher ROE is preferred in most cases, there are several other factors we should consider before drawing 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 Compagnie Générale des Établissements Michelin, which is 10.87%. Compagnie Générale des Établissements Michelin’s ROE exceeds its cost by 4.16%, which is a big tick. Some of its peers with higher ROE may face a cost which exceeds returns, which is unsustainable and far less desirable than Compagnie Générale des Établissements Michelin’s case of positive discrepancy. 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
Essentially, profit margin shows how much money the company makes after paying for all its expenses. The other component, asset turnover, illustrates how much revenue Compagnie Générale des Établissements Michelin can make from its 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 ROE can be artificially increased through excessive borrowing, we should check Compagnie Générale des Établissements Michelin’s historic debt-to-equity ratio. At 25.39%, Compagnie Générale des Établissements Michelin’s debt-to-equity ratio appears low and indicates that Compagnie Générale des Établissements Michelin still has room to increase leverage and grow its profits.
Next Steps:
While ROE is a relatively simple calculation, it can be broken down into different ratios, each telling a different story about the strengths and weaknesses of a company. Even though Compagnie Générale des Établissements Michelin 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 Compagnie Générale des Établissements Michelin’s return with a possible increase should the company decide to increase its debt levels. Although ROE can be a useful metric, it is only a small part of diligent research.
For Compagnie Générale des Établissements Michelin, there are three important aspects you should further examine:
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 Compagnie Générale des Établissements Michelin 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 Compagnie Générale des Établissements Michelin is currently mispriced by the market.
Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Compagnie Générale des Établissements Michelin? 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.
