Ossen Innovation Co Ltd (NASDAQ:OSN) generated a below-average return on equity of 5.57% in the past 12 months, while its industry returned 8.28%. Though OSN’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 OSN’s below-average returns. I will take you through how metrics such as financial leverage impact ROE which may affect the overall sustainability of OSN’s returns. Check out our latest analysis for Ossen Innovation
What you must know about ROE
Return on Equity (ROE) is a measure of Ossen Innovation’s profit relative to its shareholders’ equity. An ROE of 5.57% implies $0.06 returned on every $1 invested. 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 Ossen Innovation’s equity capital deployed. Its cost of equity is 17.53%. Given a discrepancy of -11.96% between return and cost, this indicated that Ossen Innovation 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
The first component is profit margin, which measures how much of sales is retained after the company pays for all its expenses. Asset turnover reveals how much revenue can be generated from Ossen Innovation’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 Ossen Innovation’s debt-to-equity level. At 28.25%, Ossen Innovation’s debt-to-equity ratio appears low and indicates that Ossen Innovation still has room to increase leverage and grow its profits.
What this means for you:
Are you a shareholder? OSN’s below-industry ROE is disappointing, furthermore, its returns were not even high enough to cover its own cost of equity. However, investors shouldn’t despair since ROE is not inflated by excessive debt, which means OSN 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 you are considering investing in OSN, looking at ROE on its own is not enough to make a well-informed decision. I recommend you do additional fundamental analysis by looking through our most recent infographic report on Ossen Innovation 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.