Etn Fr. Colruyt NV (ENXTBR:COLR) delivered an ROE of 17.47% over the past 12 months, which is an impressive feat relative to its industry average of 12.04% during the same period. While the impressive ratio tells us that COLR has made significant profits from little equity capital, ROE doesn’t tell us if COLR has borrowed debt to make this happen. We’ll take a closer look today at factors like financial leverage to determine whether COLR’s ROE is actually sustainable. See our latest analysis for Etn. Fr. Colruyt
What you must know about ROE
Return on Equity (ROE) is a measure of Etn. Fr. Colruyt’s profit relative to its shareholders’ equity. An ROE of 17.47% implies €0.17 returned on every €1 invested. 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
Returns are usually compared to costs to measure the efficiency of capital. Etn. Fr. Colruyt’s cost of equity is 8.19%. Given a positive discrepancy of 9.28% between return and cost, this indicates that Etn. Fr. Colruyt pays less for its capital than what it generates in return, which is a sign of capital efficiency. 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 Etn. Fr. Colruyt’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 artificially increased through excessive borrowing, we should check Etn. Fr. Colruyt’s historic debt-to-equity ratio. At 1.25%, Etn. Fr. Colruyt’s debt-to-equity ratio appears low 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. Etn. Fr. Colruyt’s above-industry ROE is encouraging, and is also in excess of 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 Etn. Fr. Colruyt, I’ve put together three key aspects you should look at:
- 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 Etn. Fr. Colruyt 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 Etn. Fr. Colruyt is currently mispriced by the market.
- Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Etn. Fr. Colruyt? 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.