Should You Expect GreenTree Hospitality Group Ltd (NYSE:GHG) To Continue Delivering An ROE Of 20.44%?
This article is intended for those of you who are at the beginning of your investing journey and want to begin learning the link between company’s fundamentals and stock market performance.
With an ROE of 20.44%, GreenTree Hospitality Group Ltd (NYSE:GHG) outpaced its own industry which delivered a less exciting 13.20% over the past year. Superficially, this looks great since we know that GHG has generated big profits with little equity capital; however, ROE doesn’t tell us how much GHG has borrowed in debt. We’ll take a closer look today at factors like financial leverage to determine whether GHG’s ROE is actually sustainable.
View our latest analysis for GreenTree Hospitality Group
Breaking down Return on Equity
Return on Equity (ROE) is a measure of GreenTree Hospitality Group’s profit relative to its shareholders’ equity. For example, if the company invests $1 in the form of equity, it will generate $0.20 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 GreenTree Hospitality Group, which is 8.94%. Given a positive discrepancy of 11.50% between return and cost, this indicates that GreenTree Hospitality Group pays less for its capital than what it generates in return, which is a sign of capital efficiency. 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
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 GreenTree Hospitality Group’s 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 GreenTree Hospitality Group currently has. Currently, GreenTree Hospitality Group 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.
Next Steps:
ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. GreenTree Hospitality Group’s above-industry ROE is encouraging, and is also in excess of 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. Although ROE can be a useful metric, it is only a small part of diligent research.
For GreenTree Hospitality Group, I’ve compiled three fundamental factors you should look at:
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.
Valuation: What is GreenTree Hospitality Group 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 GreenTree Hospitality Group is currently mispriced by the market.
Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of GreenTree Hospitality Group? 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 past 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. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.
