Enduro Royalty Trust (NYSE:NDRO) outperformed the Oil and Gas Exploration and Production industry on the basis of its ROE – producing a higher 9.50% relative to the peer average of 9.19% over the past 12 months. Superficially, this looks great since we know that NDRO has generated big profits with little equity capital; however, ROE doesn’t tell us how much NDRO has borrowed in debt. Today, we’ll take a closer look at some factors like financial leverage to see how sustainable NDRO’s ROE is. Check out our latest analysis for Enduro Royalty Trust
Peeling the layers of ROE – trisecting a company’s profitability
Return on Equity (ROE) weighs Enduro Royalty Trust’s profit against the level of its shareholders’ equity. For example, if the company invests $1 in the form of equity, it will generate $0.09 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 measured against cost of equity in order to determine the efficiency of Enduro Royalty Trust’s equity capital deployed. Its cost of equity is 8.49%. Given a positive discrepancy of 1.01% between return and cost, this indicates that Enduro Royalty Trust 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:
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 shows how much revenue Enduro Royalty Trust can generate with its current 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 Enduro Royalty Trust currently has. Currently, Enduro Royalty Trust 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 a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. Enduro Royalty Trust’s ROE is impressive relative to the industry average and also covers 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. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.
For Enduro Royalty Trust, I’ve put together three essential factors 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. Future Earnings: How does Enduro Royalty Trust’s growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
- 3. Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Enduro Royalty Trust? 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.