I am writing today to help inform people who are new to the stock market and looking to gauge the potential return on investment in Orchids Paper Products Company (NYSEMKT:TIS).
Orchids Paper Products Company (NYSEMKT:TIS) generated a below-average return on equity of 3.76% in the past 12 months, while its industry returned 15.67%. Though TIS’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 TIS’s below-average returns. I will take you through how metrics such as financial leverage impact ROE which may affect the overall sustainability of TIS’s returns. See our latest analysis for Orchids Paper Products
Breaking down Return on Equity
Return on Equity (ROE) weighs Orchids Paper Products’s profit against the level of its shareholders’ equity. For example, if the company invests $1 in the form of equity, it will generate $0.038 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
Returns are usually compared to costs to measure the efficiency of capital. Orchids Paper Products’s cost of equity is 15.38%. This means Orchids Paper Products’s returns actually do not cover its own cost of equity, with a discrepancy of -11.63%. This isn’t sustainable as it implies, very simply, that the company 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
The first component is profit margin, which measures how much of sales is retained after the company pays for all its expenses. Asset turnover shows how much revenue Orchids Paper Products can generate with its current 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 Orchids Paper Products’s debt-to-equity level. The debt-to-equity ratio currently stands at a balanced 123.44%, meaning the ROE is a result of its capacity to produce profit growth without a huge debt burden.
While ROE is a relatively simple calculation, it can be broken down into different ratios, each telling a different story about the strengths and weaknesses of a company. Orchids Paper Products’s below-industry ROE is disappointing, furthermore, its returns were not even high enough to cover its own cost of equity. Although, its appropriate level of leverage means investors can be more confident in the sustainability of Orchids Paper Products’s return with a possible increase should the company decide to increase its debt levels. Although ROE can be a useful metric, it is only a small part of diligent research.
For Orchids Paper Products, I’ve put together three pertinent factors you should further examine:
- 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 Orchids Paper Products’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 Orchids Paper Products? 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.