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Virco Mfg Corporation (NASDAQ:VIRC) generated a below-average return on equity of 0.54% in the past 12 months, while its industry returned 12.04%. An investor may attribute an inferior ROE to a relatively inefficient performance, and whilst this can often be the case, knowing the nuts and bolts of the ROE calculation may change that perspective and give you a deeper insight into VIRC’s past performance. I will take you through how metrics such as financial leverage impact ROE which may affect the overall sustainability of VIRC’s returns. View our latest analysis for Virco Mfg
Breaking down ROE — the mother of all ratios
Return on Equity (ROE) is a measure of Virco Mfg’s profit relative to its shareholders’ equity. For example, if the company invests $1 in the form of equity, it will generate $0.01 in earnings from this. 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 measured against cost of equity in order to determine the efficiency of Virco Mfg’s equity capital deployed. Its cost of equity is 8.49%. Given a discrepancy of -7.95% between return and cost, this indicated that Virco Mfg may be paying more for its capital than what it’s generating in return. ROE can be dissected into three distinct 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
Essentially, profit margin shows how much money the company makes after paying for all its expenses. Asset turnover shows how much revenue Virco Mfg 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 the company’s capital structure is. Since ROE can be inflated by excessive debt, we need to examine Virco Mfg’s debt-to-equity level. Currently the debt-to-equity ratio stands at a low 22.25%, which means Virco Mfg still has headroom to take on more leverage in order to increase profits.
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. Virco Mfg exhibits a weak ROE against its peers, as well as insufficient levels to cover its own cost of equity this year. However, ROE is not likely to be inflated by excessive debt funding, giving shareholders more conviction in the sustainability of returns, which has headroom to increase further. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.
For Virco Mfg, I’ve compiled three key factors you should look at:
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.
Management:Have insiders been ramping up their shares to take advantage of the market’s sentiment for Virco Mfg’s future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Virco Mfg? 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 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.