Stratus Properties Inc’s (NASDAQ:STRS) most recent return on equity was a substandard 7.89% relative to its industry performance of 10.35% over the past year. STRS’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 STRS’s performance. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of STRS’s returns. Let me show you what I mean by this. Check out our latest analysis for Stratus Properties
Breaking down ROE — the mother of all ratios
Return on Equity (ROE) is a measure of Stratus Properties’s profit relative to its shareholders’ equity. For example, if the company invests $1 in the form of equity, it will generate $0.08 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 Stratus Properties’s equity capital deployed. Its cost of equity is 10.95%. Since Stratus Properties’s return does not cover its cost, with a difference of -3.06%, this means its current use of equity is not efficient and not sustainable. Very simply, Stratus Properties pays more for its capital than what it generates 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
Essentially, profit margin shows how much money the company makes after paying for all its expenses. Asset turnover reveals how much revenue can be generated from Stratus Properties’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 artificially increased through excessive borrowing, we should check Stratus Properties’s historic debt-to-equity ratio. At 169.98%, Stratus Properties’s debt-to-equity ratio appears relatively high and indicates the below-average ROE is already being generated by significant leverage levels.
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. Stratus Properties’s ROE is underwhelming relative to the industry average, and its returns were also not strong enough to cover its own cost of equity. Although, its appropriate level of leverage means investors can be more confident in the sustainability of Stratus Properties’s return with a possible increase should the company decide to increase its debt levels. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.
For Stratus Properties, I’ve put together 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.
- Future Earnings: How does Stratus Properties’s growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
- Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Stratus Properties? 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.