With A Recent ROE Of 0.92%, Can Carpetright plc (LSE:CPR) Catch Up To Its Industry?
Carpetright plc’s (LSE:CPR) most recent return on equity was a substandard 0.92% relative to its industry performance of 16.11% over the past year. Though CPR'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 CPR's below-average returns. Today I will look at how components such as financial leverage can influence ROE which may impact the sustainability of CPR's returns. View our latest analysis for Carpetright
What you must know about ROE
Return on Equity (ROE) is a measure of CPR’s profit relative to its shareholders’ equity. It essentially shows how much CPR 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
Returns are usually compared to costs to measure the efficiency of capital. CPR’s cost of equity is 8.30%. This means CPR’s returns actually do not cover its own cost of equity, with a discrepancy of -7.38%. 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:
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 CPR can generate with its current asset base. And finally, financial leverage is simply how much of assets are funded by equity, which exhibits how sustainable CPR’s capital structure is. Since ROE can be artificially increased through excessive borrowing, we should check CPR’s historic debt-to-equity ratio. At 28.59%, CPR’s debt-to-equity ratio appears low and indicates that CPR still has room to increase leverage and grow its profits.
What this means for you:
Are you a shareholder? CPR’s below-industry ROE is disappointing, furthermore, its returns were not even high enough to cover its own cost of equity. Since its existing ROE is not fuelled by unsustainable debt, investors shouldn’t give up as CPR 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 CPR 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 Carpetright 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.
