Did Cineplex Inc (TSX:CGX) Create Value For Shareholders?
Cineplex Inc (TSX:CGX) delivered an ROE of 9.99% over the past 12 months, which is an impressive feat relative to its industry average of 9.67% during the same period. On the surface, this looks fantastic since we know that CGX has made large profits from little equity capital; however, ROE doesn’t tell us if management have borrowed heavily to make this happen. Today, we’ll take a closer look at some factors like financial leverage to see how sustainable CGX’s ROE is. See our latest analysis for CGX
Breaking down Return on Equity
Return on Equity (ROE) weighs CGX’s profit against the level of its shareholders’ equity. For example, if CGX invests $1 in the form of equity, it will generate $0.1 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 CGX, which is 8.49%. Since CGX’s return covers its cost in excess of 1.50%, its use of equity capital is efficient and likely to be sustainable. Simply put, CGX 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:
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 CGX is with its cost management. Asset turnover shows how much revenue CGX can generate with its current asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. Since ROE can be inflated by excessive debt, we need to examine CGX’s debt-to-equity level. At 77.90%, CGX’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.
What this means for you:
Are you a shareholder? CGX’s ROE is impressive relative to the industry average and also covers its cost of equity. Since ROE is not inflated by excessive debt, it might be a good time to add more of CGX to your portfolio if your personal research is confirming what the ROE is telling you.
Are you a potential investor? If you are considering investing in CGX, looking at ROE on its own is not enough to make a well-informed decision. I recommend you do additional fundamental analysis by looking through our most recent infographic report on Cineplex to help you make a more informed investment decision. If you are not interested in CGX anymore, you can use our free platform to see our list of stocks with Return on Equity over 20%.
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.
