Is Electro Scientific Industries Inc’s (NASDAQ:ESIO) ROE Of 12.17% Sustainable?
Electro Scientific Industries Inc (NASDAQ:ESIO) delivered an ROE of 12.17% over the past 12 months, which is an impressive feat relative to its industry average of 10.39% during the same period. Superficially, this looks great since we know that ESIO has generated big profits with little equity capital; however, ROE doesn’t tell us how much ESIO has borrowed in debt. Today, we’ll take a closer look at some factors like financial leverage to see how sustainable ESIO’s ROE is. Check out our latest analysis for Electro Scientific Industries
Breaking down ROE — the mother of all ratios
Return on Equity (ROE) weighs Electro Scientific Industries’s profit against the level of its shareholders’ equity. An ROE of 12.17% implies $0.12 returned on every $1 invested. 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. Electro Scientific Industries’s cost of equity is 9.02%. Given a positive discrepancy of 3.14% between return and cost, this indicates that Electro Scientific Industries pays less for its capital than what it generates in return, which is a sign of capital efficiency. 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
Basically, profit margin measures how much of revenue trickles down into earnings which illustrates how efficient the business is with its cost management. Asset turnover reveals how much revenue can be generated from Electro Scientific Industries’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 Electro Scientific Industries’s debt-to-equity level. The debt-to-equity ratio currently stands at a low 6.97%, meaning the above-average ROE is due to its capacity to produce profit growth without a huge debt burden.
Next Steps:
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. Electro Scientific Industries exhibits a strong ROE against its peers, as well as sufficient returns to cover its cost of equity. ROE is not likely to be inflated by excessive debt funding, giving shareholders more conviction in the sustainability of high returns. Although ROE can be a useful metric, it is only a small part of diligent research.
For Electro Scientific Industries, I’ve compiled three essential aspects 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 Electro Scientific Industries 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 Electro Scientific Industries is currently mispriced by the market.
Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Electro Scientific Industries? 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.
