STORE Capital Corporation (NYSE:STOR) delivered a less impressive 5.89% ROE over the past year, compared to the 8.29% return generated by its industry. STOR'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 STOR’s performance. Today I will look at how components such as financial leverage can influence ROE which may impact the sustainability of STOR's returns. View our latest analysis for STORE Capital
What you must know about ROE
Return on Equity (ROE) is a measure of STOR’s profit relative to its shareholders’ equity. It essentially shows how much STOR can generate in earnings given the amount of equity it has raised. 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
Returns are usually compared to costs to measure the efficiency of capital. STOR’s cost of equity is 8.49%. Since STOR’s return does not cover its cost, with a difference of -2.61%, this means its current use of equity is not efficient and not sustainable. Very simply, STOR 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
Basically, profit margin measures how much of revenue trickles down into earnings which illustrates how efficient STOR is with its cost management. Asset turnover reveals how much revenue can be generated from STOR’s asset base. And finally, financial leverage is simply how much of assets are funded by equity, which exhibits how sustainable STOR’s capital structure is. Since financial leverage can artificially inflate ROE, we need to look at how much debt STOR currently has. The debt-to-equity ratio currently stands at a sensible 80.52%, meaning the ROE is a result of its capacity to produce profit growth without a huge debt burden.
What this means for you:
Are you a shareholder? STOR’s below-industry ROE is disappointing, furthermore, its returns were not even high enough to cover its own cost of equity. However, investors shouldn’t despair since ROE is not inflated by excessive debt, which means STOR still has room to improve shareholder returns by raising debt to fund new investments.
Are you a potential investor? If you are considering investing in STOR, 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 STORE Capital to help you make a more informed investment decision. If you are not interested in STOR anymore, you can use our free platform to see our list of stocks with Return on Equity over 20%.
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.