Sypris Solutions Inc (NASDAQ:SYPR) delivered an ROE of 64.80% over the past 12 months, which is an impressive feat relative to its industry average of 19.20% during the same period. Superficially, this looks great since we know that SYPR has generated big profits with little equity capital; however, ROE doesn’t tell us how much SYPR has borrowed in debt. We’ll take a closer look today at factors like financial leverage to determine whether SYPR’s ROE is actually sustainable. See our latest analysis for SYPR
Breaking down ROE — the mother of all ratios
Return on Equity (ROE) is a measure of SYPR’s profit relative to its shareholders’ equity. For example, if SYPR invests $1 in the form of equity, it will generate $0.65 in earnings from this. 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 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 SYPR, which is 10.91%. Given a positive discrepancy of 53.89% between return and cost, this indicates that SYPR pays less for its capital than what it generates in return, which is a sign of capital efficiency. ROE can be split up into three useful 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. The other component, asset turnover, illustrates how much revenue SYPR can make from its 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 SYPR’s capital structure is. Since ROE can be artificially increased through excessive borrowing, we should check SYPR’s historic debt-to-equity ratio. Currently the debt-to-equity ratio stands at a low 44.87%, which means its above-average ROE is driven by its ability to grow its profit without a significant debt burden.
What this means for you:
Are you a shareholder? SYPR’s ROE is impressive relative to the industry average and also covers its cost of equity. Since ROE is not inflated by excessive debt, it might be a good time to add more of SYPR to your portfolio if your personal research is confirming what the ROE is telling you.
Are you a potential investor? If you are considering investing in SYPR, basing your decision on ROE alone is certainly not sufficient. I recommend you do additional fundamental analysis by looking through our most recent infographic report on Sypris Solutions to help you make a more informed investment decision. If you are not interested in SYPR anymore, you can use our free platform to see our 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.