iFresh Inc (NASDAQ:IFMK) outperformed the Food Retail industry on the basis of its ROE – producing a higher 19.07% relative to the peer average of 13.73% over the past 12 months. But what is more interesting is whether IFMK can sustain this above-average ratio. This can be measured by looking at the company’s financial leverage. With more debt, IFMK can invest even more and earn more money, thus pushing up its returns. However, ROE only measures returns against equity, not debt. This can be distorted, so let’s take a look at it further. View our latest analysis for iFresh
What you must know about ROE
Return on Equity (ROE) weighs IFMK’s profit against the level of its shareholders’ equity.An ROE of 19.07% implies $0.19 returned on every $1 invested, so the higher the return, the better.If investors diversify their portfolio by industry, they may want to maximise their return in the Food Retail sector by investing in the highest returning stock.But this can be misleading as each company has different costs of equity and also varying debt levels, which could artificially push up ROE whilst accumulating high interest expense.
Return on Equity = Net Profit ÷ Shareholders Equity
Returns are usually compared to costs to measure the efficiency of capital. IFMK’s cost of equity is 8.49%. Given a positive discrepancy of 10.57% between return and cost, this indicates that IFMK pays less for its capital than what it generates in return, which is a sign of capital efficiency. 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
Basically, profit margin measures how much of revenue trickles down into earnings which illustrates how efficient IFMK is with its cost management.Asset turnover shows how much revenue IFMK can generate with its current 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 IFMK’s capital structure is.We can determine if IFMK’s ROE is inflated by borrowing high levels of debt. Generally, a balanced capital structure means its returns will be sustainable over the long run. We can examine this by looking at IFMK’s debt-to-equity ratio. The most recent ratio is 245.78%, which is relatively high, indicating IFMK’s above-average ROE is generated by its high leverage and its ability to grow profit hinges on a sizeable debt burden.
Why is ROE called the mother of all ratios
ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. IFMK’s ROE is impressive relative to the industry average and also covers 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. Though there are other vital factors we need to consider before we conclude whether or not IFMK’s returns are sustainable. I recommend you see our latest FREE analysis report to find out more about other measures!
If you are not interested in IFMK anymore, you can use our free platform to see my 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.