Owens Realty Mortgage Inc (NYSEMKT:ORM): Can It Deliver A Superior ROE To The Industry?
Owens Realty Mortgage Inc (AMEX:ORM) delivered a less impressive 5.41% ROE over the past year, compared to the 8.92% return generated by its industry. ORM’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 ORM’s performance. I will take you through how metrics such as financial leverage impact ROE which may affect the overall sustainability of ORM’s returns. See our latest analysis for Owens Realty Mortgage
Peeling the layers of ROE – trisecting a company’s profitability
Return on Equity (ROE) weighs Owens Realty Mortgage’s profit against the level of its shareholders’ equity. For example, if the company invests $1 in the form of equity, it will generate $0.05 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 assessed against cost of equity, which is measured using the Capital Asset Pricing Model (CAPM) – but let’s not dive into the details of that today. For now, let’s just look at the cost of equity number for Owens Realty Mortgage, which is 8.49%. This means Owens Realty Mortgage’s returns actually do not cover its own cost of equity, with a discrepancy of -3.09%. 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 dissected into three distinct 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
Basically, profit margin measures how much of revenue trickles down into earnings which illustrates how efficient the business is with its cost management. The other component, asset turnover, illustrates how much revenue Owens Realty Mortgage can make from its asset base. And finally, financial leverage is simply how much of assets are funded by equity, which exhibits how sustainable the company’s capital structure is. Since financial leverage can artificially inflate ROE, we need to look at how much debt Owens Realty Mortgage currently has. Currently the debt-to-equity ratio stands at a low 13.38%, which means Owens Realty Mortgage still has headroom to take on more leverage in order to increase profits.
What this means for you:
Are you a shareholder? ORM’s ROE is underwhelming relative to the industry average, and its returns were also not strong enough to cover its own cost of equity. Since its existing ROE is not fuelled by unsustainable debt, investors shouldn’t give up as ORM still has capacity to improve shareholder returns by borrowing to invest in new projects in the future. 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 ORM, basing your decision on ROE alone is certainly not sufficient. I recommend you do additional fundamental analysis by looking through our most recent infographic report on Owens Realty Mortgage 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.
