Firma Oponiarska Debica Spólka Akcyjna (WSE:DBC) generated a below-average return on equity of 11.17% in the past 12 months, while its industry returned 13.61%. Though DBC’s recent performance is underwhelming, it is useful to understand what ROE is made up of and how it should be interpreted. Knowing these components can change your views on DBC’s below-average returns. I will take you through how metrics such as financial leverage impact ROE which may affect the overall sustainability of DBC’s returns. View our latest analysis for Firma Oponiarska Debica Spólka Akcyjna
Breaking down ROE — the mother of all ratios
Firstly, Return on Equity, or ROE, is simply the percentage of last years’ earning against the book value of shareholders’ equity. It essentially shows how much the company can generate in earnings given the amount of equity it has raised. 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 Firma Oponiarska Debica Spólka Akcyjna, which is 9.87%. Some of Firma Oponiarska Debica Spólka Akcyjna’s peers may have a higher ROE but its cost of equity could exceed this return, leading to an unsustainable negative discrepancy i.e. the company spends more than it earns. This is not the case for Firma Oponiarska Debica Spólka Akcyjna which is reassuring. ROE can be dissected into three distinct 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 shows how much revenue Firma Oponiarska Debica Spólka Akcyjna can generate with its current 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 the company’s capital structure is. Since ROE can be inflated by excessive debt, we need to examine Firma Oponiarska Debica Spólka Akcyjna’s debt-to-equity level. Currently Firma Oponiarska Debica Spólka Akcyjna has virtually no debt, which means its returns are predominantly driven by equity capital. This could explain why Firma Oponiarska Debica Spólka Akcyjna’s’ ROE is lower than its industry peers, most of which may have some degree of debt in its business.
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. While Firma Oponiarska Debica Spólka Akcyjna exhibits a weak ROE against its peers, its returns are sufficient enough to cover its cost of equity. Its appropriate level of leverage means investors can be more confident in the sustainability of Firma Oponiarska Debica Spólka Akcyjna’s return with a possible increase should the company decide to increase its debt levels. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.
For Firma Oponiarska Debica Spólka Akcyjna, I’ve put together three important aspects 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 Firma Oponiarska Debica Spólka Akcyjna 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 Firma Oponiarska Debica Spólka Akcyjna is currently mispriced by the market.
- Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Firma Oponiarska Debica Spólka Akcyjna? 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.