Can Hostess Brands Inc’s (NASDAQ:TWNK) ROE Continue To Surpass The Industry Average?
With an ROE of 17.53%, Hostess Brands Inc (NASDAQ:TWNK) outpaced its own industry which delivered a less exciting 11.86% over the past year. While the impressive ratio tells us that TWNK has made significant profits from little equity capital, ROE doesn’t tell us if TWNK has borrowed debt to make this happen. We’ll take a closer look today at factors like financial leverage to determine whether TWNK’s ROE is actually sustainable. See our latest analysis for Hostess Brands
Breaking down ROE — the mother of all ratios
Return on Equity (ROE) weighs Hostess Brands’s profit against the level of its shareholders’ equity. It essentially shows how much the company can generate in earnings given the amount of equity it has raised. 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 Hostess Brands’s equity capital deployed. Its cost of equity is 8.49%. Since Hostess Brands’s return covers its cost in excess of 9.03%, its use of equity capital is efficient and likely to be sustainable. Simply put, Hostess Brands 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. Asset turnover shows how much revenue Hostess Brands can generate with its current 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 artificially increased through excessive borrowing, we should check Hostess Brands’s historic debt-to-equity ratio. Currently the debt-to-equity ratio stands at a reasonable 67.85%, which means its above-average ROE is driven by its ability to grow its profit without a significant debt burden.
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. Hostess Brands exhibits a strong ROE against its peers, as well as sufficient returns to cover its cost of equity. Its high ROE is not likely to be driven by high debt. Therefore, investors may have more confidence in the sustainability of this level of returns going forward. Although ROE can be a useful metric, it is only a small part of diligent research.
For Hostess Brands, I’ve compiled three fundamental 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 Hostess Brands 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 Hostess Brands is currently mispriced by the market.
Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Hostess Brands? 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.
