With An ROE Of 20.06%, Has Fortune Brands Home & Security Inc’s (NYSE:FBHS) Management Done Well?
I am writing today to help inform people who are new to the stock market and want to begin learning the link between Fortune Brands Home & Security Inc (NYSE:FBHS)’s return fundamentals and stock market performance.
Fortune Brands Home & Security Inc (NYSE:FBHS) delivered an ROE of 20.06% over the past 12 months, which is an impressive feat relative to its industry average of 12.77% during the same period. On the surface, this looks fantastic since we know that FBHS has made large profits from little equity capital; however, ROE doesn’t tell us if management have borrowed heavily to make this happen. We’ll take a closer look today at factors like financial leverage to determine whether FBHS’s ROE is actually sustainable. View out our latest analysis for Fortune Brands Home & Security
Peeling the layers of ROE – trisecting a company’s profitability
Return on Equity (ROE) is a measure of Fortune Brands Home & Security’s profit relative to its shareholders’ equity. For example, if the company invests $1 in the form of equity, it will generate $0.20 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 Fortune Brands Home & Security’s equity capital deployed. Its cost of equity is 9.53%. Given a positive discrepancy of 10.53% between return and cost, this indicates that Fortune Brands Home & Security pays less for its capital than what it generates in return, which is a sign of capital efficiency. 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 the business is with its cost management. Asset turnover reveals how much revenue can be generated from Fortune Brands Home & Security’s asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. Since ROE can be inflated by excessive debt, we need to examine Fortune Brands Home & Security’s debt-to-equity level. At 80.06%, Fortune Brands Home & Security’s debt-to-equity ratio appears sensible and indicates the above-average ROE is generated from its capacity to increase profit without a large debt burden.
Next Steps:
ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. Fortune Brands Home & Security’s ROE is impressive relative to the industry average and also covers its cost of equity. Its high ROE is not likely to be driven by high debt. Therefore, investors may have more confidence in the sustainability of this level of returns going forward. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.
For Fortune Brands Home & Security, I’ve compiled three relevant factors you should further research:
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 Fortune Brands Home & Security 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 Fortune Brands Home & Security is currently mispriced by the market.
Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Fortune Brands Home & Security? 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.
