I am writing today to help inform people who are new to the stock market and want a simplistic look at the return on Kulicke and Soffa Industries Inc (NASDAQ:KLIC) stock.
Kulicke and Soffa Industries Inc (NASDAQ:KLIC) generated a below-average return on equity of 4.87% in the past 12 months, while its industry returned 13.83%. KLIC’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 KLIC’s performance. Today I will look at how components such as financial leverage can influence ROE which may impact the sustainability of KLIC’s returns. Check out our latest analysis for Kulicke and Soffa Industries
Peeling the layers of ROE – trisecting a company’s profitability
Return on Equity (ROE) weighs Kulicke and Soffa Industries’s profit against the level of its shareholders’ equity. For example, if the company invests $1 in the form of equity, it will generate $0.049 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 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 Kulicke and Soffa Industries, which is 9.96%. Given a discrepancy of -5.09% between return and cost, this indicated that Kulicke and Soffa Industries may be paying more for its capital than what it’s generating in return. ROE can be dissected into three distinct 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
Basically, profit margin measures how much of revenue trickles down into earnings which illustrates how efficient the business is with its cost management. Asset turnover reveals how much revenue can be generated from Kulicke and Soffa Industries’s asset base. Finally, financial leverage will be our main focus today. It shows how much of assets are funded by equity and can show how sustainable the company’s capital structure is. Since ROE can be inflated by excessive debt, we need to examine Kulicke and Soffa Industries’s debt-to-equity level. Currently the debt-to-equity ratio stands at a low 1.85%, which means Kulicke and Soffa Industries still has headroom to take on more leverage in order to increase profits.
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. Kulicke and Soffa Industries exhibits a weak ROE against its peers, as well as insufficient levels to cover its own cost of equity this year. However, 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 Kulicke and Soffa Industries, I’ve compiled 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 Kulicke and Soffa Industries 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 Kulicke and Soffa Industries is currently mispriced by the market.
- Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Kulicke and Soffa Industries? 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.