National Storage Affiliates Trust (NYSE:NSA) delivered a less impressive 4.49% ROE over the past year, compared to the 7.62% return generated by its industry. Though NSA’s recent performance is underwhelming, it is useful to understand what ROE is made up of and how it should be interpreted. Knowing these components can change your views on NSA’s below-average returns. Today I will look at how components such as financial leverage can influence ROE which may impact the sustainability of NSA’s returns. See our latest analysis for NSA
Breaking down Return on Equity
Return on Equity (ROE) weighs NSA’s profit against the level of its shareholders’ equity. For example, if NSA invests $1 in the form of equity, it will generate $0.04 in earnings from this. Generally speaking, a higher ROE is preferred; however, there are other factors we must also consider before making any conclusions.
Return on Equity = Net Profit ÷ Shareholders Equity
ROE is measured against cost of equity in order to determine the efficiency of NSA’s equity capital deployed. Its cost of equity is 8.49%. Given a discrepancy of -4.00% between return and cost, this indicated that NSA may be paying more for its capital than what it’s generating 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:
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 NSA is with its cost management. Asset turnover reveals how much revenue can be generated from NSA’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 NSA’s capital structure is. Since ROE can be artificially increased through excessive borrowing, we should check NSA’s historic debt-to-equity ratio. Currently the debt-to-equity ratio stands at a balanced 111.59%, 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? NSA 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 NSA 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 NSA has been on your watch list for a while, making an investment decision based on ROE alone is unwise. I recommend you do additional fundamental analysis by looking through our most recent infographic report on National Storage Affiliates Trust 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.