Should You Expect iShares Trust – iShares Dow Jones US ETF (NYSEARCA:IYY) To Continue Delivering An ROE Of 21.80%?
iShares Trust – iShares Dow Jones US ETF (ARCA:IYY) outperformed the Asset Management and Custody Banks industry on the basis of its ROE – producing a higher 21.80% relative to the peer average of 13.60% over the past 12 months. Superficially, this looks great since we know that IYY has generated big profits with little equity capital; however, ROE doesn’t tell us how much IYY has borrowed in debt. Today, we’ll take a closer look at some factors like financial leverage to see how sustainable IYY’s ROE is. See our latest analysis for iShares Trust – iShares Dow Jones U.S. ETF
Peeling the layers of ROE – trisecting a company’s profitability
Return on Equity (ROE) weighs iShares Trust – iShares Dow Jones U.S. ETF’s profit against the level of its shareholders’ equity. For example, if the company invests $1 in the form of equity, it will generate $0.22 in earnings from this. Generally speaking, a higher ROE is preferred; however, there are other factors we must also consider before making 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 iShares Trust – iShares Dow Jones U.S. ETF, which is 11.67%. Since iShares Trust – iShares Dow Jones U.S. ETF’s return covers its cost in excess of 10.13%, its use of equity capital is efficient and likely to be sustainable. Simply put, iShares Trust – iShares Dow Jones U.S. ETF 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:
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 reveals how much revenue can be generated from iShares Trust – iShares Dow Jones U.S. ETF’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 iShares Trust – iShares Dow Jones U.S. ETF currently has. Currently the debt-to-equity ratio stands at a low 2.12%, which means its above-average ROE is driven by its ability to grow its profit without a significant debt burden.
Next Steps:
ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. iShares Trust – iShares Dow Jones U.S. ETF’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 iShares Trust – iShares Dow Jones U.S. ETF, I’ve put together three essential factors 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 iShares Trust – iShares Dow Jones U.S. ETF 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 iShares Trust – iShares Dow Jones U.S. ETF is currently mispriced by the market.
3. Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of iShares Trust – iShares Dow Jones U.S. ETF? 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.
