The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to start learning about core concepts of fundamental analysis on practical examples from today’s market.
With an ROE of 13.5%, Grodno Spólka Akcyjna (WSE:GRN) outpaced its own industry which delivered a less exciting 7.9% over the past year. Superficially, this looks great since we know that GRN has generated big profits with little equity capital; however, ROE doesn’t tell us how much GRN has borrowed in debt. Today, we’ll take a closer look at some factors like financial leverage to see how sustainable GRN’s ROE is.
Peeling the layers of ROE – trisecting a company’s profitability
Return on Equity (ROE) is a measure of Grodno Spólka Akcyjna’s profit relative to its shareholders’ equity. An ROE of 13.5% implies PLN0.13 returned on every PLN1 invested. 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 Grodno Spólka Akcyjna’s equity capital deployed. Its cost of equity is 8.7%. Since Grodno Spólka Akcyjna’s return covers its cost in excess of 4.8%, its use of equity capital is efficient and likely to be sustainable. Simply put, Grodno Spólka Akcyjna 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:
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. Asset turnover shows how much revenue Grodno Spólka Akcyjna can generate with its current asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. Since financial leverage can artificially inflate ROE, we need to look at how much debt Grodno Spólka Akcyjna currently has. The debt-to-equity ratio currently stands at a balanced 96.0%, meaning the above-average ROE is due to its capacity to produce profit growth without a huge debt burden.
ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. Grodno Spólka Akcyjna exhibits a strong ROE against its peers, as well as sufficient returns to cover 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. Although ROE can be a useful metric, it is only a small part of diligent research.
For Grodno Spólka Akcyjna, I’ve put together three key aspects you should further examine:
- 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.
- Future Earnings: How does Grodno Spólka Akcyjna’s growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
- Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Grodno Spólka Akcyjna? 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 past 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. For errors that warrant correction please contact the editor at firstname.lastname@example.org.