Advertisement
U.S. markets closed
  • S&P Futures

    5,304.25
    -4.00 (-0.08%)
     
  • Dow Futures

    40,140.00
    -36.00 (-0.09%)
     
  • Nasdaq Futures

    18,465.00
    -38.75 (-0.21%)
     
  • Russell 2000 Futures

    2,145.20
    +6.80 (+0.32%)
     
  • Crude Oil

    83.11
    -0.06 (-0.07%)
     
  • Gold

    2,254.80
    +16.40 (+0.73%)
     
  • Silver

    25.10
    +0.18 (+0.74%)
     
  • EUR/USD

    1.0786
    -0.0007 (-0.06%)
     
  • 10-Yr Bond

    4.2060
    +0.0100 (+0.24%)
     
  • Vix

    13.01
    +0.23 (+1.80%)
     
  • GBP/USD

    1.2627
    +0.0005 (+0.04%)
     
  • USD/JPY

    151.3720
    0.0000 (0.00%)
     
  • Bitcoin USD

    70,893.74
    +1,391.98 (+2.00%)
     
  • CMC Crypto 200

    885.54
    0.00 (0.00%)
     
  • FTSE 100

    7,952.62
    +20.64 (+0.26%)
     
  • Nikkei 225

    40,368.58
    +200.51 (+0.50%)
     

Will Empire Company Limited (TSE:EMP.A) Continue To Underperform Its Industry?

Empire Company Limited (TSX:EMP.A) generated a below-average return on equity of 2.93% in the past 12 months, while its industry returned 15.98%. EMP.A’s results could indicate a relatively inefficient operation to its peers, and while this may be the case, it is important to understand what ROE is made up of and how it should be interpreted. Knowing these components could change your view on EMP.A’s performance. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of EMP.A’s returns. Let me show you what I mean by this. See our latest analysis for Empire

Peeling the layers of ROE – trisecting a company’s profitability

Return on Equity (ROE) weighs Empire’s profit against the level of its shareholders’ equity. For example, if the company invests CA$1 in the form of equity, it will generate CA$0.03 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. Empire’s cost of equity is 8.43%. Since Empire’s return does not cover its cost, with a difference of -5.50%, this means its current use of equity is not efficient and not sustainable. Very simply, Empire pays more 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:

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

TSX:EMP.A Last Perf Mar 12th 18
TSX:EMP.A Last Perf Mar 12th 18

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 Empire’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 financial leverage can artificially inflate ROE, we need to look at how much debt Empire currently has. Currently the debt-to-equity ratio stands at a low 48.68%, which means Empire still has headroom to take on more leverage in order to increase profits.

TSX:EMP.A Historical Debt Mar 12th 18
TSX:EMP.A Historical Debt Mar 12th 18

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. Empire’s ROE is underwhelming relative to the industry average, and its returns were also not strong enough to cover its own cost of equity. Although, its appropriate level of leverage means investors can be more confident in the sustainability of Empire’s return with a possible increase should the company decide to increase its debt levels. Although ROE can be a useful metric, it is only a small part of diligent research.

For Empire, there are three relevant aspects you should look at:

  1. 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.

  2. Valuation: What is Empire 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 Empire is currently mispriced by the market.

  3. Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Empire? 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.

Advertisement