What You Must Know About Fomento de Construcciones y Contratas SA.’s (BME:FCC) ROE
Fomento de Construcciones y Contratas SA. (BME:FCC) delivered an ROE of 13.17% over the past 12 months, which is an impressive feat relative to its industry average of 8.13% during the same period. Superficially, this looks great since we know that FCC has generated big profits with little equity capital; however, ROE doesn’t tell us how much FCC has borrowed in debt. In this article, we’ll closely examine some factors like financial leverage to evaluate the sustainability of FCC’s ROE. See our latest analysis for Fomento de Construcciones y Contratas
Peeling the layers of ROE – trisecting a company’s profitability
Return on Equity (ROE) weighs Fomento de Construcciones y Contratas’s profit against the level of its shareholders’ equity. For example, if the company invests €1 in the form of equity, it will generate €0.13 in earnings from this. In most cases, a higher ROE is preferred; however, there are many other factors we must consider prior to making any investment decisions.
Return on Equity = Net Profit ÷ Shareholders Equity
ROE is measured against cost of equity in order to determine the efficiency of Fomento de Construcciones y Contratas’s equity capital deployed. Its cost of equity is 12.16%. This means Fomento de Construcciones y Contratas returns enough to cover its own cost of equity, with a buffer of 1.01%. This sustainable practice implies that the company 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
The first component is profit margin, which measures how much of sales is retained after the company pays for all its expenses. The other component, asset turnover, illustrates how much revenue Fomento de Construcciones y Contratas can make from its 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 Fomento de Construcciones y Contratas’s historic debt-to-equity ratio. At over 2.5 times, Fomento de Construcciones y Contratas’s debt-to-equity ratio is very high and indicates the above-average ROE is generated by significant leverage levels.
Next Steps:
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. Fomento de Construcciones y Contratas exhibits a strong ROE against its peers, as well as sufficient returns to cover 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 Fomento de Construcciones y Contratas’s returns. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.
For Fomento de Construcciones y Contratas, there are three essential 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 Fomento de Construcciones y Contratas 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 Fomento de Construcciones y Contratas is currently mispriced by the market.
Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Fomento de Construcciones y Contratas? 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.
