The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want a simplistic look at the return on CorePoint Lodging Inc (NYSE:LQ) stock.
With an ROE of 16.83%, CorePoint Lodging Inc (NYSE:LQ) outpaced its own industry which delivered a less exciting 13.67% over the past year. Superficially, this looks great since we know that LQ has generated big profits with little equity capital; however, ROE doesn’t tell us how much LQ has borrowed in debt. Today, we’ll take a closer look at some factors like financial leverage to see how sustainable LQ’s ROE is. Check out our latest analysis for La Quinta Holdings
Breaking down ROE — the mother of all ratios
Return on Equity (ROE) is a measure of La Quinta Holdings’s profit relative to its shareholders’ equity. It essentially shows how much the company can generate in earnings given the amount of equity it has raised. 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 La Quinta Holdings, which is 16.48%. Given a positive discrepancy of 0.35% between return and cost, this indicates that La Quinta Holdings 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:
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. The other component, asset turnover, illustrates how much revenue La Quinta Holdings can make from its 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 La Quinta Holdings’s debt-to-equity level. The debt-to-equity ratio currently stands at a high 209.43%, meaning the above-average ratio is a result of a large amount of debt.
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. La Quinta Holdings’s above-industry ROE is encouraging, and is also in excess of its cost of equity. With debt capital in excess of equity, ROE may be inflated by the use of debt funding, raising questions over the sustainability of the company’s returns. Although ROE can be a useful metric, it is only a small part of diligent research.
For La Quinta Holdings, I’ve put together three relevant factors you should further research:
- 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 La Quinta Holdings 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 La Quinta Holdings is currently mispriced by the market.
- Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of La Quinta Holdings? 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.