Is Gladstone Capital Corporation’s (GLAD) 16.11% ROE Good Enough Compared To Its Industry?
With an ROE of 16.11%, Gladstone Capital Corporation (NASDAQ:GLAD) outpaced its own industry which delivered a less exciting 11.73% over the past year. On the surface, this looks fantastic since we know that GLAD has made large profits from little equity capital; however, ROE doesn’t tell us if management have borrowed heavily to make this happen. Today, we’ll take a closer look at some factors like financial leverage to see how sustainable GLAD’s ROE is. View our latest analysis for Gladstone Capital
Peeling the layers of ROE – trisecting a company’s profitability
Return on Equity (ROE) is a measure of GLAD’s profit relative to its shareholders’ equity. For example, if GLAD invests $1 in the form of equity, it will generate $0.16 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 GLAD, which is 11.11%. This means GLAD returns enough to cover its own cost of equity, with a buffer of 5.01%. This sustainable practice implies that the company 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
Essentially, profit margin shows how much money the company makes after paying for all its expenses. The other component, asset turnover, illustrates how much revenue GLAD can make from its asset base. And finally, financial leverage is simply how much of assets are funded by equity, which exhibits how sustainable GLAD’s capital structure is. Since ROE can be artificially increased through excessive borrowing, we should check GLAD’s historic debt-to-equity ratio. At 65.40%, GLAD’s debt-to-equity ratio appears sensible and indicates the above-average ROE is generated from its capacity to increase profit without a large debt burden.
What this means for you:
Are you a shareholder? GLAD’s above-industry ROE is encouraging, and is also in excess of its cost of equity. Since ROE is not inflated by excessive debt, it might be a good time to add more of GLAD 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 you are considering investing in GLAD, looking at ROE on its own is not enough to make a well-informed decision. I recommend you do additional fundamental analysis by looking through our most recent infographic report on Gladstone Capital 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.
