Is Kapsch TrafficCom AG’s (VIE:KTCG) 12.19% ROE Strong Compared To Its Industry?
This analysis is intended to introduce important early concepts to people who are starting to invest and want to learn about Return on Equity using a real-life example.
With an ROE of 12.19%, Kapsch TrafficCom AG (VIE:KTCG) outpaced its own industry which delivered a less exciting 10.99% over the past year. Superficially, this looks great since we know that KTCG has generated big profits with little equity capital; however, ROE doesn’t tell us how much KTCG has borrowed in debt. We’ll take a closer look today at factors like financial leverage to determine whether KTCG’s ROE is actually sustainable.
View our latest analysis for Kapsch TrafficCom
What you must know about ROE
Return on Equity (ROE) is a measure of Kapsch TrafficCom’s profit relative to its shareholders’ equity. An ROE of 12.19% implies €0.12 returned on every €1 invested. 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 Kapsch TrafficCom’s equity capital deployed. Its cost of equity is 10.79%. Given a positive discrepancy of 1.40% between return and cost, this indicates that Kapsch TrafficCom pays less for its capital than what it generates in return, which is a sign of capital efficiency. 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
The first component is profit margin, which measures how much of sales is retained after the company pays for all its expenses. Asset turnover reveals how much revenue can be generated from Kapsch TrafficCom’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 Kapsch TrafficCom’s debt-to-equity level. The debt-to-equity ratio currently stands at a sensible 73.26%, meaning the above-average ROE is due to its capacity to produce profit growth without a huge debt burden.
Next Steps:
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. Kapsch TrafficCom’s above-industry ROE is encouraging, and is also in excess of its cost of equity. ROE is not likely to be inflated by excessive debt funding, giving shareholders more conviction in the sustainability of high returns. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.
For Kapsch TrafficCom, I’ve compiled three relevant factors you should look at:
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 Kapsch TrafficCom 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 Kapsch TrafficCom is currently mispriced by the market.
Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Kapsch TrafficCom? 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 past 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. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.
