Did Westlake Chemical Corporation (NYSE:WLK) Create Value For Shareholders?
Westlake Chemical Corporation (NYSE:WLK) delivered an ROE of 15.01% over the past 12 months, which is an impressive feat relative to its industry average of 13.90% during the same period. Superficially, this looks great since we know that WLK has generated big profits with little equity capital; however, ROE doesn’t tell us how much WLK has borrowed in debt. In this article, we’ll closely examine some factors like financial leverage to evaluate the sustainability of WLK’s ROE. See our latest analysis for Westlake Chemical
Peeling the layers of ROE – trisecting a company’s profitability
Return on Equity (ROE) weighs Westlake Chemical’s profit against the level of its shareholders’ equity. For example, if the company invests $1 in the form of equity, it will generate $0.15 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
Returns are usually compared to costs to measure the efficiency of capital. Westlake Chemical’s cost of equity is 9.34%. Since Westlake Chemical’s return covers its cost in excess of 5.67%, its use of equity capital is efficient and likely to be sustainable. Simply put, Westlake Chemical pays less for its capital than what it generates in return. ROE can be broken down into three different 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
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 Westlake Chemical’s 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 Westlake Chemical’s historic debt-to-equity ratio. The debt-to-equity ratio currently stands at a sensible 73.59%, meaning the above-average ROE is due to its capacity to produce profit growth without a huge debt burden.
What this means for you:
Are you a shareholder? WLK exhibits a strong ROE against its peers, as well as sufficient returns to cover its cost of equity. Since ROE is not inflated by excessive debt, it might be a good time to add more of WLK to your portfolio if your personal research is confirming what the ROE is telling you. If you’re looking for new ideas for high-returning stocks, you should take a look at our free platform to see the list of stocks with Return on Equity over 20%.
Are you a potential investor? If you are considering investing in WLK, 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 Westlake Chemical to help you make a more informed investment decision.
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.
