Did Marsh & McLennan Companies Inc (NYSE:MMC) Create Value For Shareholders?
Marsh & McLennan Companies Inc (NYSE:MMC) outperformed the Insurance Brokers industry on the basis of its ROE – producing a higher 20.30% relative to the peer average of 9.41% over the past 12 months. Superficially, this looks great since we know that MMC has generated big profits with little equity capital; however, ROE doesn’t tell us how much MMC has borrowed in debt. In this article, we’ll closely examine some factors like financial leverage to evaluate the sustainability of MMC’s ROE. See our latest analysis for Marsh & McLennan Companies
Peeling the layers of ROE – trisecting a company’s profitability
Return on Equity (ROE) is a measure of Marsh & McLennan Companies’s profit relative to its shareholders’ equity. For example, if the company invests $1 in the form of equity, it will generate $0.2 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 measured against cost of equity in order to determine the efficiency of Marsh & McLennan Companies’s equity capital deployed. Its cost of equity is 8.49%. This means Marsh & McLennan Companies returns enough to cover its own cost of equity, with a buffer of 11.80%. This sustainable practice implies that the company 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 the business is with its cost management. The other component, asset turnover, illustrates how much revenue Marsh & McLennan Companies can make from its asset base. And finally, financial leverage is simply how much of assets are funded by equity, which exhibits how sustainable the company’s capital structure is. Since ROE can be artificially increased through excessive borrowing, we should check Marsh & McLennan Companies’s historic debt-to-equity ratio. At 78.88%, Marsh & McLennan Companies’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.
Next Steps:
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. Marsh & McLennan Companies exhibits a strong ROE against its peers, as well as sufficient returns to cover its cost of equity. Its high ROE is not likely to be driven by high debt. Therefore, investors may have more confidence in the sustainability of this level of returns going forward. Although ROE can be a useful metric, it is only a small part of diligent research.
For Marsh & McLennan Companies, I’ve put together three key factors 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 Marsh & McLennan Companies 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 Marsh & McLennan Companies is currently mispriced by the market.
Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Marsh & McLennan Companies? 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.
