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Is Pulse Seismic Inc’s (TSE:PSD) ROE Of 51.8% Sustainable?

This article is intended for those of you who are at the beginning of your investing journey and want to begin learning the link between company’s fundamentals and stock market performance.

Pulse Seismic Inc (TSE:PSD) delivered an ROE of 51.8% over the past 12 months, which is an impressive feat relative to its industry average of 7.0% during the same period. Superficially, this looks great since we know that PSD has generated big profits with little equity capital; however, ROE doesn’t tell us how much PSD has borrowed in debt. In this article, we’ll closely examine some factors like financial leverage to evaluate the sustainability of PSD’s ROE.

View our latest analysis for Pulse Seismic

Breaking down ROE — the mother of all ratios

Return on Equity (ROE) weighs Pulse Seismic’s profit against the level of its shareholders’ equity. It essentially shows how much the company can generate in earnings given the amount of equity it has raised. 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

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 Pulse Seismic, which is 13.5%. Given a positive discrepancy of 38.4% between return and cost, this indicates that Pulse Seismic pays less for its capital than what it generates in return, which is a sign of capital efficiency. 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

TSX:PSD Last Perf September 11th 18
TSX:PSD Last Perf September 11th 18

Essentially, profit margin shows how much money the company makes after paying for all its expenses. The other component, asset turnover, illustrates how much revenue Pulse Seismic can make from its 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 Pulse Seismic’s historic debt-to-equity ratio. Currently, Pulse Seismic 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.

TSX:PSD Historical Debt September 11th 18
TSX:PSD Historical Debt September 11th 18

Next Steps:

ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. Pulse Seismic exhibits a strong ROE against its peers, as well as sufficient returns to cover its cost of equity. ROE is not likely to be inflated by excessive debt funding, giving shareholders more conviction in the sustainability of high returns. Although ROE can be a useful metric, it is only a small part of diligent research.

For Pulse Seismic, there are three essential aspects you should look at:

  1. 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.

  2. Valuation: What is Pulse Seismic 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 Pulse Seismic is currently mispriced by the market.

  3. Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Pulse Seismic? 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 past 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. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.

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