What You Must Know About UTStarcom Holdings Corp’s (UTSI) ROE
With an ROE of 9.29%, UTStarcom Holdings Corp (NASDAQ:UTSI) outpaced its own industry which delivered a less exciting 8.55% over the past year. While the impressive ratio tells us that UTSI has made significant profits from little equity capital, ROE doesn’t tell us if UTSI has borrowed debt to make this happen. We’ll take a closer look today at factors like financial leverage to determine whether UTSI’s ROE is actually sustainable. Check out our latest analysis for UTStarcom Holdings
Breaking down ROE — the mother of all ratios
Return on Equity (ROE) is a measure of UTSI’s profit relative to its shareholders’ equity. An ROE of 9.29% implies $0.09 returned on every $1 invested. While a higher ROE is preferred in most cases, there are several other factors we should consider before drawing any conclusions.
Return on Equity = Net Profit ÷ Shareholders Equity
Returns are usually compared to costs to measure the efficiency of capital. UTSI’s cost of equity is 9.88%. Since UTSI’s return does not cover its cost, with a difference of -0.60%, this means its current use of equity is not efficient and not sustainable. Very simply, UTSI 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:
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. The other component, asset turnover, illustrates how much revenue UTSI can make from its asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. Since ROE can be inflated by excessive debt, we need to examine UTSI’s debt-to-equity level. Currently, UTSI has no debt which means its returns are driven purely by equity capital. Therefore, the level of financial leverage has no impact on ROE, and the ratio is a representative measure of the efficiency of all its capital employed firm-wide.
What this means for you:
Are you a shareholder? UTSI’s above-industry ROE is noteworthy, but it was not high enough to cover its own cost of equity. However, investors shouldn’t despair since ROE is not inflated by excessive debt, which means UTSI 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 UTSI 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 UTStarcom Holdings 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.
