The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want a simplistic look at the return on Dorchester Minerals LP (NASDAQ:DMLP) stock.
With an ROE of 46.03%, Dorchester Minerals LP (NASDAQ:DMLP) outpaced its own industry which delivered a less exciting 11.31% over the past year. While the impressive ratio tells us that DMLP has made significant profits from little equity capital, ROE doesn’t tell us if DMLP has borrowed debt to make this happen. We’ll take a closer look today at factors like financial leverage to determine whether DMLP’s ROE is actually sustainable. View out our latest analysis for Dorchester Minerals
Peeling the layers of ROE – trisecting a company’s profitability
Return on Equity (ROE) is a measure of Dorchester Minerals’s profit relative to its shareholders’ equity. It essentially shows how much the company can generate in earnings given the amount of equity it has raised. 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
Returns are usually compared to costs to measure the efficiency of capital. Dorchester Minerals’s cost of equity is 8.61%. This means Dorchester Minerals returns enough to cover its own cost of equity, with a buffer of 37.43%. This sustainable practice implies that the company 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:
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 the business is with its cost management. The other component, asset turnover, illustrates how much revenue Dorchester Minerals can make from its asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. Since financial leverage can artificially inflate ROE, we need to look at how much debt Dorchester Minerals currently has. Currently, Dorchester Minerals has no debt which means its returns are driven purely by equity capital. Therefore, the level of financial leverage has no impact on ROE, and the ratio is a representative measure of the efficiency of all its capital employed firm-wide.
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. Dorchester Minerals 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 Dorchester Minerals, I’ve put together three fundamental factors 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 Dorchester Minerals 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 Dorchester Minerals is currently mispriced by the market.
- Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Dorchester Minerals? 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.