Should You Expect CMC Markets Plc (LSE:CMCX) To Continue Delivering An ROE Of 25.89%?
CMC Markets Plc (LSE:CMCX) delivered an ROE of 25.89% over the past 12 months, which is an impressive feat relative to its industry average of 13.55% during the same period. While the impressive ratio tells us that CMCX has made significant profits from little equity capital, ROE doesn’t tell us if CMCX has borrowed debt to make this happen. We’ll take a closer look today at factors like financial leverage to determine whether CMCX’s ROE is actually sustainable. View our latest analysis for CMC Markets
Breaking down ROE — the mother of all ratios
Return on Equity (ROE) is a measure of CMCX’s profit relative to its shareholders’ equity. For example, if CMCX invests £1 in the form of equity, it will generate £0.26 in earnings from this. 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
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 CMCX, which is 9.67%. Since CMCX’s return covers its cost in excess of 16.22%, its use of equity capital is efficient and likely to be sustainable. Simply put, CMCX 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
Essentially, profit margin shows how much money the company makes after paying for all its expenses. The other component, asset turnover, illustrates how much revenue CMCX can make from its asset base. And finally, financial leverage is simply how much of assets are funded by equity, which exhibits how sustainable CMCX’s capital structure is. Since ROE can be inflated by excessive debt, we need to examine CMCX’s debt-to-equity level. The debt-to-equity ratio currently stands at a low 12.57%, meaning the above-average ROE is due to its capacity to produce profit growth without a huge debt burden.
What this means for you:
Are you a shareholder? CMCX exhibits a strong ROE against its peers, as well as sufficient returns to cover its cost of equity. Since ROE is not inflated by excessive debt, it might be a good time to add more of CMCX to your portfolio if your personal research is confirming what the ROE is telling you. If you’re looking for new ideas for high-returning stocks, you should take a look at our free platform to see the list of stocks with Return on Equity over 20%.
Are you a potential investor? If CMCX has been on your watch list for a while, making an investment decision based on ROE alone is unwise. I recommend you do additional fundamental analysis by looking through our most recent infographic report on CMC Markets to help you make a more informed investment decision.
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.
