I am writing today to help inform people who are new to the stock market and looking to gauge the potential return on investment in Ruth’s Hospitality Group Inc (NASDAQ:RUTH).
Ruth’s Hospitality Group Inc (NASDAQ:RUTH) outperformed the Restaurants industry on the basis of its ROE – producing a higher 37.44% relative to the peer average of 13.67% over the past 12 months. On the surface, this looks fantastic since we know that RUTH has made large profits from little equity capital; however, ROE doesn’t tell us if management have borrowed heavily to make this happen. Today, we’ll take a closer look at some factors like financial leverage to see how sustainable RUTH’s ROE is. Check out our latest analysis for Ruth’s Hospitality Group
Breaking down ROE — the mother of all ratios
Return on Equity (ROE) is a measure of Ruth’s Hospitality Group’s profit relative to its shareholders’ equity. An ROE of 37.44% implies $0.37 returned on every $1 invested. Generally speaking, a higher ROE is preferred; however, there are other factors we must also consider before making any conclusions.
Return on Equity = Net Profit ÷ Shareholders Equity
ROE is assessed against cost of equity, which is measured using the Capital Asset Pricing Model (CAPM) – but let’s not dive into the details of that today. For now, let’s just look at the cost of equity number for Ruth’s Hospitality Group, which is 9.79%. Since Ruth’s Hospitality Group’s return covers its cost in excess of 27.65%, its use of equity capital is efficient and likely to be sustainable. Simply put, Ruth’s Hospitality Group 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:
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 Ruth’s Hospitality Group’s asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. Since ROE can be artificially increased through excessive borrowing, we should check Ruth’s Hospitality Group’s historic debt-to-equity ratio. The debt-to-equity ratio currently stands at a low 49.09%, meaning the above-average ROE is due to its capacity to produce profit growth without a huge debt burden.
While ROE is a relatively simple calculation, it can be broken down into different ratios, each telling a different story about the strengths and weaknesses of a company. Ruth’s Hospitality Group 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. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.
For Ruth’s Hospitality Group, there are three important 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 Ruth’s Hospitality Group 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 Ruth’s Hospitality Group is currently mispriced by the market.
- Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Ruth’s Hospitality Group? 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.