This article is intended for those of you who are at the beginning of your investing journey and want to better understand how you can grow your money by investing in Pro-Dex Inc (NASDAQ:PDEX).
Pro-Dex Inc (NASDAQ:PDEX) delivered an ROE of 12.45% over the past 12 months, which is an impressive feat relative to its industry average of 11.63% during the same period. Superficially, this looks great since we know that PDEX has generated big profits with little equity capital; however, ROE doesn’t tell us how much PDEX has borrowed in debt. Today, we’ll take a closer look at some factors like financial leverage to see how sustainable PDEX’s ROE is. See our latest analysis for Pro-Dex
What you must know about ROE
Return on Equity (ROE) is a measure of Pro-Dex’s profit relative to its shareholders’ equity. An ROE of 12.45% implies $0.12 returned on every $1 invested. 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 Pro-Dex’s equity capital deployed. Its cost of equity is 8.59%. Given a positive discrepancy of 3.86% between return and cost, this indicates that Pro-Dex 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:
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 the business is with its cost management. The other component, asset turnover, illustrates how much revenue Pro-Dex 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 Pro-Dex’s historic debt-to-equity ratio. Currently Pro-Dex has virtually no debt, which means its returns are predominantly driven 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.
While ROE is a relatively simple calculation, it can be broken down into different ratios, each telling a different story about the strengths and weaknesses of a company. Pro-Dex’s ROE is impressive relative to the industry average and also covers 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. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.
For Pro-Dex, there are three fundamental aspects 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.
- Valuation: What is Pro-Dex 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 Pro-Dex is currently mispriced by the market.
- Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Pro-Dex? 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.