This analysis is intended to introduce important early concepts to people who are starting to invest and want to start learning about core concepts of fundamental analysis on practical examples from today’s market.
Oxford Industries Inc (NYSE:OXM) outperformed the Apparel, Accessories and Luxury Goods industry on the basis of its ROE – producing a higher 15.3% relative to the peer average of 12.0% over the past 12 months. While the impressive ratio tells us that OXM has made significant profits from little equity capital, ROE doesn’t tell us if OXM has borrowed debt to make this happen. We’ll take a closer look today at factors like financial leverage to determine whether OXM’s ROE is actually sustainable.
Peeling the layers of ROE – trisecting a company’s profitability
Firstly, Return on Equity, or ROE, is simply the percentage of last years’ earning against the book value of shareholders’ equity. An ROE of 15.3% implies $0.15 returned on every $1 invested. While a higher ROE is preferred in most cases, there are several other factors we should consider before drawing any conclusions.
Return on Equity = Net Profit ÷ Shareholders Equity
ROE is measured against cost of equity in order to determine the efficiency of Oxford Industries’s equity capital deployed. Its cost of equity is 8.6%. Given a positive discrepancy of 6.8% between return and cost, this indicates that Oxford Industries 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
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 Oxford Industries’s asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. Since ROE can be inflated by excessive debt, we need to examine Oxford Industries’s debt-to-equity level. Currently the debt-to-equity ratio stands at a low 16.3%, which means its above-average ROE is driven by its ability to grow its profit without a significant debt burden.
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. Oxford Industries’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. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.
For Oxford Industries, I’ve put together three relevant factors you should further examine:
- 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 Oxford 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 Oxford Industries is currently mispriced by the market.
- Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Oxford 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 past 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. For errors that warrant correction please contact the editor at email@example.com.