With an ROE of 19.25%, Willdan Group Inc (NASDAQ:WLDN) outpaced its own industry which delivered a less exciting 12.50% over the past year. On the surface, this looks fantastic since we know that WLDN has made large profits from little equity capital; however, ROE doesn’t tell us if management have borrowed heavily to make this happen. We’ll take a closer look today at factors like financial leverage to determine whether WLDN’s ROE is actually sustainable. View our latest analysis for Willdan Group
Breaking down Return on Equity
Return on Equity (ROE) weighs WLDN’s profit against the level of its shareholders’ equity. It essentially shows how much WLDN can generate in earnings given the amount of equity it has raised. 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 measured against cost of equity in order to determine the efficiency of WLDN’s equity capital deployed. Its cost of equity is 8.49%. This means WLDN returns enough to cover its own cost of equity, with a buffer of 10.76%. This sustainable practice implies that the company 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:
ROE = profit margin × asset turnover × financial leverage
ROE = (annual net profit ÷ sales) × (sales ÷ assets) × (assets ÷ shareholders’ equity)
ROE = annual net profit ÷ shareholders’ equity
Basically, profit margin measures how much of revenue trickles down into earnings which illustrates how efficient WLDN is with its cost management. The other component, asset turnover, illustrates how much revenue WLDN can make from its asset base. And finally, financial leverage is simply how much of assets are funded by equity, which exhibits how sustainable WLDN’s capital structure is. Since ROE can be inflated by excessive debt, we need to examine WLDN’s debt-to-equity level. The debt-to-equity ratio currently stands at a low 7.14%, 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? WLDN exhibits a strong ROE against its peers, as well as sufficient returns to cover its cost of equity. Since its high ROE is not likely driven by high debt, it might be a good time to top up on your current holdings if your fundamental research reaffirms this analysis.
Are you a potential investor? If you are considering investing in WLDN, looking at ROE on its own is not enough to make a well-informed decision. I recommend you do additional fundamental analysis by looking through our most recent infographic report on Willdan Group to help you make a more informed investment decision. If you are not interested in WLDN 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.