BJ’s Restaurants Inc (NASDAQ:BJRI) delivered an ROE of 18.67% over the past 12 months, which is an impressive feat relative to its industry average of 13.89% during the same period. Superficially, this looks great since we know that BJRI has generated big profits with little equity capital; however, ROE doesn’t tell us how much BJRI has borrowed in debt. In this article, we’ll closely examine some factors like financial leverage to evaluate the sustainability of BJRI’s ROE. See our latest analysis for BJ’s Restaurants
Peeling the layers of ROE – trisecting a company’s profitability
Return on Equity (ROE) is a measure of BJ’s Restaurants’s profit relative to its shareholders’ equity. For example, if the company invests $1 in the form of equity, it will generate $0.19 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 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 BJ’s Restaurants, which is 10.26%. Since BJ’s Restaurants’s return covers its cost in excess of 8.41%, its use of equity capital is efficient and likely to be sustainable. Simply put, BJ’s Restaurants pays less for its capital than what it generates in return. ROE can be dissected into three distinct 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
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 BJ’s Restaurants’s 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 inflated by excessive debt, we need to examine BJ’s Restaurants’s debt-to-equity level. At 58.97%, BJ’s Restaurants’s debt-to-equity ratio appears sensible and indicates the above-average ROE is generated from its capacity to increase profit without a large debt burden.
ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. BJ’s Restaurants 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 BJ’s Restaurants, I’ve compiled three essential factors 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 BJ’s Restaurants 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 BJ’s Restaurants is currently mispriced by the market.
- Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of BJ’s Restaurants? 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.