Krynicki Recykling Spólka Akcyjna (WSE:KRC) generated a below-average return on equity of 8.99% in the past 12 months, while its industry returned 9.92%. KRC’s results could indicate a relatively inefficient operation to its peers, and while this may be the case, it is important to understand what ROE is made up of and how it should be interpreted. Knowing these components could change your view on KRC’s performance. I will take you through how metrics such as financial leverage impact ROE which may affect the overall sustainability of KRC’s returns. View our latest analysis for Krynicki Recykling Spólka Akcyjna
Breaking down ROE — the mother of all ratios
Return on Equity (ROE) weighs Krynicki Recykling Spólka Akcyjna’s profit against the level of its shareholders’ equity. For example, if the company invests PLN1 in the form of equity, it will generate PLN0.09 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 Krynicki Recykling Spólka Akcyjna, which is 8.18%. Krynicki Recykling Spólka Akcyjna’s ROE exceeds its cost by 0.82%, which is a big tick. Some of its peers with higher ROE may face a cost which exceeds returns, which is unsustainable and far less desirable than Krynicki Recykling Spólka Akcyjna’s case of positive discrepancy. ROE can be split up into three useful 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 Krynicki Recykling Spólka Akcyjna can generate with its current asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. Since ROE can be artificially increased through excessive borrowing, we should check Krynicki Recykling Spólka Akcyjna’s historic debt-to-equity ratio. Currently the debt-to-equity ratio stands at a reasonable 69.17%, which means its ROE is driven by its ability to grow its profit without a significant debt burden.
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. While Krynicki Recykling Spólka Akcyjna exhibits a weak ROE against its peers, its returns are sufficient enough to cover its cost of equity. Also, ROE is not likely to be inflated by excessive debt funding, giving shareholders more conviction in the sustainability of returns, which has headroom to increase further. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.
For Krynicki Recykling Spólka Akcyjna, there are three important 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 Krynicki Recykling 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 Krynicki Recykling Spólka Akcyjna is currently mispriced by the market.
- Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Krynicki Recykling 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.