Duluth Holdings Inc (NASDAQ:DLTH) outperformed the Internet and Direct Marketing Retail industry on the basis of its ROE – producing a higher 17.72% relative to the peer average of 10.97% over the past 12 months. While the impressive ratio tells us that DLTH has made significant profits from little equity capital, ROE doesn’t tell us if DLTH has borrowed debt to make this happen. Today, we’ll take a closer look at some factors like financial leverage to see how sustainable DLTH’s ROE is. Check out our latest analysis for Duluth Holdings
What you must know about ROE
Return on Equity (ROE) is a measure of DLTH’s profit relative to its shareholders’ equity. For example, if DLTH invests $1 in the form of equity, it will generate $0.18 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 DLTH, which is 12.65%. This means DLTH returns enough to cover its own cost of equity, with a buffer of 5.07%. This sustainable practice implies that the company pays less 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:
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 DLTH can make from its asset base. Finally, financial leverage will be our main focus today. It shows how much of assets are funded by equity and can show how sustainable DLTH’s capital structure is. Since financial leverage can artificially inflate ROE, we need to look at how much debt DLTH currently has. The debt-to-equity ratio currently stands at a low 18.85%, 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? DLTH’s ROE is impressive relative to the industry average and also covers its cost of equity. Since its high ROE is not likely driven by high debt, it might be a good time to top up on your current holdings if your fundamental research reaffirms this analysis. 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 DLTH 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 Duluth Holdings 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.