Advertisement
U.S. markets close in 6 hours 9 minutes
  • S&P 500

    5,253.04
    +4.55 (+0.09%)
     
  • Dow 30

    39,775.79
    +15.71 (+0.04%)
     
  • Nasdaq

    16,412.95
    +13.42 (+0.08%)
     
  • Russell 2000

    2,121.58
    +7.23 (+0.34%)
     
  • Crude Oil

    82.53
    +1.18 (+1.45%)
     
  • Gold

    2,227.90
    +15.20 (+0.69%)
     
  • Silver

    24.70
    -0.05 (-0.21%)
     
  • EUR/USD

    1.0817
    -0.0013 (-0.12%)
     
  • 10-Yr Bond

    4.2240
    +0.0280 (+0.67%)
     
  • GBP/USD

    1.2641
    +0.0003 (+0.02%)
     
  • USD/JPY

    151.2440
    -0.0020 (-0.00%)
     
  • Bitcoin USD

    70,841.14
    +616.23 (+0.88%)
     
  • CMC Crypto 200

    885.54
    0.00 (0.00%)
     
  • FTSE 100

    7,968.67
    +36.69 (+0.46%)
     
  • Nikkei 225

    40,168.07
    -594.66 (-1.46%)
     

How Did Tower International Inc’s (NYSE:TOWR) 16.2% ROE Fare Against The Industry?

This article is intended for those of you who are at the beginning of your investing journey and want to learn about Return on Equity using a real-life example.

Tower International Inc (NYSE:TOWR) delivered an ROE of 16.2% over the past 12 months, which is an impressive feat relative to its industry average of 14.4% during the same period. While the impressive ratio tells us that TOWR has made significant profits from little equity capital, ROE doesn’t tell us if TOWR has borrowed debt to make this happen. We’ll take a closer look today at factors like financial leverage to determine whether TOWR’s ROE is actually sustainable.

See our latest analysis for Tower International

What you must know about ROE

Firstly, Return on Equity, or ROE, is simply the percentage of last years’ earning against the book value of shareholders’ equity. It essentially shows how much the company can generate in earnings given the amount of equity it has raised. 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

Returns are usually compared to costs to measure the efficiency of capital. Tower International’s cost of equity is 13.2%. Since Tower International’s return covers its cost in excess of 3.0%, its use of equity capital is efficient and likely to be sustainable. Simply put, Tower International pays less for its capital than what it generates in return. ROE can be split up into three useful 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

NYSE:TOWR Last Perf September 10th 18
NYSE:TOWR Last Perf September 10th 18

The first component is profit margin, which measures how much of sales is retained after the company pays for all its expenses. The other component, asset turnover, illustrates how much revenue Tower International 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 financial leverage can artificially inflate ROE, we need to look at how much debt Tower International currently has. The debt-to-equity ratio currently stands at a balanced 126%, meaning the above-average ROE is due to its capacity to produce profit growth without a huge debt burden.

NYSE:TOWR Historical Debt September 10th 18
NYSE:TOWR Historical Debt September 10th 18

Next Steps:

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. Tower International’s ROE is impressive relative to the industry average and also covers 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 Tower International, I’ve compiled three pertinent aspects you should further examine:

  1. 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.

  2. Valuation: What is Tower International 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 Tower International is currently mispriced by the market.

  3. Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Tower International? 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 editorial-team@simplywallst.com.

Advertisement