This article is intended for those of you who are at the beginning of your investing journey and want a simplistic look at the return on Black Hills Corporation (NYSE:BKH) stock.
With an ROE of 13.78%, Black Hills Corporation (NYSE:BKH) outpaced its own industry which delivered a less exciting 10.10% over the past year. On the surface, this looks fantastic since we know that BKH has made large profits from little equity capital; however, ROE doesn’t tell us if management have borrowed heavily to make this happen. In this article, we’ll closely examine some factors like financial leverage to evaluate the sustainability of BKH’s ROE. View out our latest analysis for Black Hills
What you must know about ROE
Return on Equity (ROE) weighs Black Hills’s profit against the level of its shareholders’ equity. For example, if the company invests $1 in the form of equity, it will generate $0.14 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 measured against cost of equity in order to determine the efficiency of Black Hills’s equity capital deployed. Its cost of equity is 9.10%. Given a positive discrepancy of 4.68% between return and cost, this indicates that Black Hills 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:
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 Black Hills 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 financial leverage can artificially inflate ROE, we need to look at how much debt Black Hills currently has. Currently the debt-to-equity ratio stands at a high 170.06%, which means its above-average ROE is driven by significant debt levels.
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. Black Hills’s ROE is impressive relative to the industry average and also covers its cost of equity. Its high debt level means its strong ROE may be driven by debt funding which raises concerns over the sustainability of Black Hills’s returns. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.
For Black Hills, I’ve compiled three relevant aspects 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 Black Hills 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 Black Hills is currently mispriced by the market.
- Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Black Hills? 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.