Should You Expect Southwestern Energy Company (NYSE:SWN) To Continue Delivering An ROE Of 52.86%?
Southwestern Energy Company (NYSE:SWN) delivered an ROE of 52.86% over the past 12 months, which is an impressive feat relative to its industry average of 10.62% during the same period. While the impressive ratio tells us that SWN has made significant profits from little equity capital, ROE doesn’t tell us if SWN has borrowed debt to make this happen. We’ll take a closer look today at factors like financial leverage to determine whether SWN’s ROE is actually sustainable. See our latest analysis for Southwestern Energy
What you must know about ROE
Return on Equity (ROE) is a measure of Southwestern Energy’s profit relative to its shareholders’ equity. For example, if the company invests $1 in the form of equity, it will generate $0.53 in earnings from this. In most cases, a higher ROE is preferred; however, there are many other factors we must consider prior to making any investment decisions.
Return on Equity = Net Profit ÷ Shareholders Equity
Returns are usually compared to costs to measure the efficiency of capital. Southwestern Energy’s cost of equity is 17.53%. Since Southwestern Energy’s return covers its cost in excess of 35.32%, its use of equity capital is efficient and likely to be sustainable. Simply put, Southwestern Energy pays less for its capital than what it generates in return. ROE can be dissected into three distinct 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 Southwestern Energy’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 Southwestern Energy’s debt-to-equity level. The debt-to-equity ratio currently stands at a high 221.93%, meaning the above-average ratio is a result of a large amount of debt.
Next Steps:
While ROE is a relatively simple calculation, it can be broken down into different ratios, each telling a different story about the strengths and weaknesses of a company. Southwestern Energy’s ROE is impressive relative to the industry average and also covers its cost of equity. With debt capital in excess of equity, ROE may be inflated by the use of debt funding, raising questions over the sustainability of the company’s returns. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.
For Southwestern Energy, I’ve put together three relevant factors you should further examine:
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 Southwestern Energy 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 Southwestern Energy is currently mispriced by the market.
Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Southwestern Energy? 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.
