Taylor Devices Inc (NASDAQ:TAYD) delivered a less impressive 3.52% ROE over the past year, compared to the 11.38% return generated by its industry. TAYD’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 TAYD’s performance. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of TAYD’s returns. Let me show you what I mean by this. Check out our latest analysis for Taylor Devices
Breaking down ROE — the mother of all ratios
Return on Equity (ROE) is a measure of Taylor Devices’s profit relative to its shareholders’ equity. For example, if the company invests $1 in the form of equity, it will generate $0.04 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 Taylor Devices’s equity capital deployed. Its cost of equity is 9.02%. Since Taylor Devices’s return does not cover its cost, with a difference of -5.50%, this means its current use of equity is not efficient and not sustainable. Very simply, Taylor Devices 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 Taylor Devices’s asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. Since ROE can be artificially increased through excessive borrowing, we should check Taylor Devices’s historic debt-to-equity ratio. Currently, Taylor Devices has no debt which means its returns are driven purely by equity capital. This could explain why Taylor Devices’s’ ROE is lower than its industry peers, most of which may have some degree of debt in its business.
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. Taylor Devices’s ROE is underwhelming relative to the industry average, and its returns were also not strong enough to cover its own cost of equity. 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. Although ROE can be a useful metric, it is only a small part of diligent research.
For Taylor Devices, I’ve compiled three pertinent 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 Taylor Devices 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 Taylor Devices is currently mispriced by the market.
- Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Taylor Devices? 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.