Eldorado Resorts Inc (NASDAQ:ERI) Delivered A Better ROE Than The Industry, Here’s Why
The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to start learning about core concepts of fundamental analysis on practical examples from today’s market.
Eldorado Resorts Inc (NASDAQ:ERI) delivered an ROE of 17.7% over the past 12 months, which is an impressive feat relative to its industry average of 15.5% during the same period. On the surface, this looks fantastic since we know that ERI has made large profits from little equity capital; however, ROE doesn’t tell us if management have borrowed heavily to make this happen. Today, we’ll take a closer look at some factors like financial leverage to see how sustainable ERI’s ROE is.
Check out our latest analysis for Eldorado Resorts
Peeling the layers of ROE – trisecting a company’s profitability
Return on Equity (ROE) is a measure of Eldorado Resorts’s profit relative to its shareholders’ equity. For example, if the company invests $1 in the form of equity, it will generate $0.18 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
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 Eldorado Resorts, which is 11.5%. This means Eldorado Resorts returns enough to cover its own cost of equity, with a buffer of 6.2%. 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:
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
The first component is profit margin, which measures how much of sales is retained after the company pays for all its expenses. Asset turnover reveals how much revenue can be generated from Eldorado Resorts’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 inflated by excessive debt, we need to examine Eldorado Resorts’s debt-to-equity level. Currently the debt-to-equity ratio stands at a high 220%, which means its above-average ROE is driven by significant debt levels.
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. Eldorado Resorts’s above-industry ROE is encouraging, and is also in excess of its cost of equity. Its high debt level means its strong ROE may be driven by debt funding which raises concerns over the sustainability of Eldorado Resorts’s returns. Although ROE can be a useful metric, it is only a small part of diligent research.
For Eldorado Resorts, there are three essential factors you should further research:
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 Eldorado Resorts 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 Eldorado Resorts is currently mispriced by the market.
Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Eldorado Resorts? 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.
