Four Seasons Education (Cayman) Inc (NYSE:FEDU) outperformed the Education Services industry on the basis of its ROE – producing a higher 20.34% relative to the peer average of 10.69% over the past 12 months. Superficially, this looks great since we know that FEDU has generated big profits with little equity capital; however, ROE doesn’t tell us how much FEDU has borrowed in debt. In this article, we’ll closely examine some factors like financial leverage to evaluate the sustainability of FEDU’s ROE. View our latest analysis for Four Seasons Education (Cayman)
Peeling the layers of ROE – trisecting a company’s profitability
Return on Equity (ROE) weighs Four Seasons Education (Cayman)’s profit against the level of its shareholders’ equity. For example, if the company invests $1 in the form of equity, it will generate $0.2 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
Returns are usually compared to costs to measure the efficiency of capital. Four Seasons Education (Cayman)’s cost of equity is 9.23%. Since Four Seasons Education (Cayman)’s return covers its cost in excess of 11.11%, its use of equity capital is efficient and likely to be sustainable. Simply put, Four Seasons Education (Cayman) 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:
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. Asset turnover reveals how much revenue can be generated from Four Seasons Education (Cayman)’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 Four Seasons Education (Cayman)’s debt-to-equity level. Currently, Four Seasons Education (Cayman) 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. Four Seasons Education (Cayman)’s ROE is impressive relative to the industry average and also covers its cost of equity. Its high ROE is not likely to be driven by high debt. Therefore, investors may have more confidence in the sustainability of this level of returns going forward. Although ROE can be a useful metric, it is only a small part of diligent research.
For Four Seasons Education (Cayman), there are three pertinent aspects you should further examine:
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 Four Seasons Education (Cayman) 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 Four Seasons Education (Cayman) is currently mispriced by the market.
3. Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Four Seasons Education (Cayman)? 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.