Should You Expect Warrior Met Coal Inc (HCC) To Continue Delivering An ROE Of 46.47%?
With an ROE of 46.47%, Warrior Met Coal Inc (NYSE:HCC) outpaced its own industry which delivered a less exciting 5.76% over the past year. On the surface, this looks fantastic since we know that HCC has made large profits from little equity capital; however, ROE doesn’t tell us if management have borrowed heavily to make this happen. We’ll take a closer look today at factors like financial leverage to determine whether HCC’s ROE is actually sustainable. See our latest analysis for HCC
Breaking down Return on Equity
Return on Equity (ROE) weighs HCC’s profit against the level of its shareholders’ equity. For example, if HCC invests $1 in the form of equity, it will generate $0.46 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 measured against cost of equity in order to determine the efficiency of HCC’s equity capital deployed. Its cost of equity is 10.65%. This means HCC returns enough to cover its own cost of equity, with a buffer of 35.82%. This sustainable practice implies that the company 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:
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 HCC is with its cost management. The other component, asset turnover, illustrates how much revenue HCC 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 HCC’s capital structure is. Since ROE can be inflated by excessive debt, we need to examine HCC’s debt-to-equity level. Currently HCC has virtually no debt, which means its returns are predominantly driven 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.
What this means for you:
Are you a shareholder? HCC’s ROE is impressive relative to the industry average and also covers its cost of equity. Since ROE is not inflated by excessive debt, it might be a good time to add more of HCC to your portfolio if your personal research is confirming what the ROE is telling you. 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 HCC 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 Warrior Met Coal 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.
