How Resolute Mining Limited (ASX:RSG) Delivered A Better ROE Than Its Industry
Resolute Mining Limited (ASX:RSG) delivered an ROE of 33.64% over the past 12 months, which is an impressive feat relative to its industry average of 11.83% during the same period. Superficially, this looks great since we know that RSG has generated big profits with little equity capital; however, ROE doesn’t tell us how much RSG has borrowed in debt. We’ll take a closer look today at factors like financial leverage to determine whether RSG’s ROE is actually sustainable. Check out our latest analysis for Resolute Mining
Peeling the layers of ROE – trisecting a company’s profitability
Firstly, Return on Equity, or ROE, is simply the percentage of last years’ earning against the book value of shareholders’ equity. For example, if RSG invests A$1 in the form of equity, it will generate A$0.34 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 measured against cost of equity in order to determine the efficiency of RSG’s equity capital deployed. Its cost of equity is 9.76%. This means RSG returns enough to cover its own cost of equity, with a buffer of 23.88%. This sustainable practice implies that the company pays less for its capital than what it generates in return. ROE can be broken down into three different 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 RSG is with its cost management. Asset turnover shows how much revenue RSG 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 RSG’s capital structure is. Since ROE can be inflated by excessive debt, we need to examine RSG’s debt-to-equity level. At 5.32%, RSG’s debt-to-equity ratio appears low and indicates the above-average ROE is generated from its capacity to increase profit without a large debt burden.
What this means for you:
Are you a shareholder? RSG’s above-industry ROE is encouraging, and is also in excess of its cost of equity. Since its high ROE is not likely driven by high debt, it might be a good time to top up on your current holdings if your fundamental research reaffirms this analysis. 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 RSG 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 Resolute Mining 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.
