How Did Ainsworth Game Technology Limited’s (ASX:AGI) 7.66% ROE Fare Against The Industry?
Ainsworth Game Technology Limited (ASX:AGI) generated a below-average return on equity of 7.66% in the past 12 months, while its industry returned 15.20%. AGI’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 AGI’s performance. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of AGI’s returns. Let me show you what I mean by this. View our latest analysis for Ainsworth Game Technology
Breaking down ROE — the mother of all ratios
Return on Equity (ROE) is a measure of Ainsworth Game Technology’s profit relative to its shareholders’ equity. For example, if the company invests A$1 in the form of equity, it will generate A$0.08 in earnings from this. 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 measured against cost of equity in order to determine the efficiency of Ainsworth Game Technology’s equity capital deployed. Its cost of equity is 8.55%. Given a discrepancy of -0.89% between return and cost, this indicated that Ainsworth Game Technology may be paying more for its capital than what it’s generating in return. ROE can be broken down into three different 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. Asset turnover shows how much revenue Ainsworth Game Technology 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 artificially increased through excessive borrowing, we should check Ainsworth Game Technology’s historic debt-to-equity ratio. At 19.44%, Ainsworth Game Technology’s debt-to-equity ratio appears low and indicates that Ainsworth Game Technology still has room to increase leverage and grow its profits.
Next Steps:
ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. Ainsworth Game Technology exhibits a weak ROE against its peers, as well as insufficient levels to cover its own cost of equity this year. Although, its appropriate level of leverage means investors can be more confident in the sustainability of Ainsworth Game Technology’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 Ainsworth Game Technology, I’ve put together three essential 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 Ainsworth Game Technology 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 Ainsworth Game Technology is currently mispriced by the market.
Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Ainsworth Game Technology? 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.
