CSS Industries Inc (NYSE:CSS) generated a below-average return on equity of 7.41% in the past 12 months, while its industry returned 11.31%. CSS’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 CSS’s performance. I will take you through how metrics such as financial leverage impact ROE which may affect the overall sustainability of CSS’s returns. View our latest analysis for CSS Industries
What you must know about ROE
Firstly, Return on Equity, or ROE, is simply the percentage of last years’ earning against the book value of shareholders’ equity. It essentially shows how much the company can generate in earnings given the amount of equity it has raised. 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 measured against cost of equity in order to determine the efficiency of CSS Industries’s equity capital deployed. Its cost of equity is 9.60%. Given a discrepancy of -2.19% between return and cost, this indicated that CSS Industries 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:
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 reveals how much revenue can be generated from CSS Industries’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 CSS Industries’s debt-to-equity level. Currently CSS Industries has virtually no debt, which means its returns are predominantly driven by equity capital. This could explain why CSS Industries’s’ ROE is lower than its industry peers, most of which may have some degree of debt in its business.
ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. CSS Industries’s ROE is underwhelming relative to the industry average, and its returns were also not strong enough to cover its own cost of equity. However, ROE is not likely to be inflated by excessive debt funding, giving shareholders more conviction in the sustainability of returns, which has headroom to increase further. Although ROE can be a useful metric, it is only a small part of diligent research.
For CSS Industries, there are three key factors you should further examine:
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 CSS Industries 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 CSS Industries is currently mispriced by the market.
3. Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of CSS Industries? 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.