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Did Ceconomy AG (FRA:CEC) Create Value For Shareholders?

The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to begin learning the link between company’s fundamentals and stock market performance.

Ceconomy AG (FRA:CEC) outperformed the Computer and Electronics Retail industry on the basis of its ROE – producing a higher 13.17% relative to the peer average of 12.30% over the past 12 months. While the impressive ratio tells us that CEC has made significant profits from little equity capital, ROE doesn’t tell us if CEC has borrowed debt to make this happen. Today, we’ll take a closer look at some factors like financial leverage to see how sustainable CEC’s ROE is.

Check out our latest analysis for Ceconomy

Peeling the layers of ROE – trisecting a company’s profitability

Return on Equity (ROE) weighs Ceconomy’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. In most cases, a higher ROE is preferred; however, there are many other factors we must consider prior to making any investment decisions.

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 Ceconomy, which is 9.23%. Given a positive discrepancy of 3.94% between return and cost, this indicates that Ceconomy pays less for its capital than what it generates in return, which is a sign of capital efficiency. 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

DB:CEC Last Perf August 13th 18
DB:CEC Last Perf August 13th 18

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 Ceconomy’s 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 financial leverage can artificially inflate ROE, we need to look at how much debt Ceconomy currently has. Currently the debt-to-equity ratio stands at a balanced 99.70%, which means its above-average ROE is driven by its ability to grow its profit without a significant debt burden.

DB:CEC Historical Debt August 13th 18
DB:CEC Historical Debt August 13th 18

Next Steps:

ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. Ceconomy’s ROE is impressive relative to the industry average and also covers its cost of equity. Its high ROE is not likely to be driven by high debt. Therefore, investors may have more confidence in the sustainability of this level of returns going forward. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.

For Ceconomy, I’ve put together three important aspects you should further research:

  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 Ceconomy 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 Ceconomy is currently mispriced by the market.

  3. Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Ceconomy? 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 past 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. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.

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