Will Kier Group plc (LSE:KIE) Continue To Underperform Its Industry?
Kier Group plc’s (LSE:KIE) most recent return on equity was a substandard 2.92% relative to its industry performance of 16.63% over the past year. An investor may attribute an inferior ROE to a relatively inefficient performance, and whilst this can often be the case, knowing the nuts and bolts of the ROE calculation may change that perspective and give you a deeper insight into KIE’s past performance. I will take you through how metrics such as financial leverage impact ROE which may affect the overall sustainability of KIE’s returns. See our latest analysis for KIE
Breaking down ROE — the mother of all ratios
Return on Equity (ROE) weighs KIE’s profit against the level of its shareholders’ equity. It essentially shows how much KIE 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 KIE’s equity capital deployed. Its cost of equity is 8.30%. This means KIE’s returns actually do not cover its own cost of equity, with a discrepancy of -5.37%. This isn’t sustainable as it implies, very simply, that the company pays more for its capital than what it generates in return. ROE can be split up into three useful 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 KIE can make from its asset base. And finally, financial leverage is simply how much of assets are funded by equity, which exhibits how sustainable KIE’s capital structure is. Since ROE can be artificially increased through excessive borrowing, we should check KIE’s historic debt-to-equity ratio. Currently the debt-to-equity ratio stands at a balanced 126.40%, which means its ROE is driven by its ability to grow its profit without a significant debt burden.
What this means for you:
Are you a shareholder? KIE exhibits a weak ROE against its peers, as well as insufficient levels to cover its own cost of equity this year. However, investors shouldn’t despair since ROE is not inflated by excessive debt, which means KIE still has room to improve shareholder returns by raising debt to fund new investments. 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 KIE, basing your decision on ROE alone is certainly not sufficient. I recommend you do additional fundamental analysis by looking through our most recent infographic report on Kier Group 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.
