With An ROE Of 20.36%, Has LCI Industries’s (NYSE:LCII) Management Done Well?
LCI Industries (NYSE:LCII) delivered an ROE of 20.36% over the past 12 months, which is an impressive feat relative to its industry average of 14.27% during the same period. Superficially, this looks great since we know that LCII has generated big profits with little equity capital; however, ROE doesn’t tell us how much LCII has borrowed in debt. We’ll take a closer look today at factors like financial leverage to determine whether LCII’s ROE is actually sustainable. Check out our latest analysis for LCI Industries
Breaking down ROE — the mother of all ratios
Return on Equity (ROE) is a measure of LCI Industries’s profit relative to its shareholders’ equity. An ROE of 20.36% implies $0.2 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
Returns are usually compared to costs to measure the efficiency of capital. LCI Industries’s cost of equity is 9.61%. Given a positive discrepancy of 10.75% between return and cost, this indicates that LCI Industries 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:
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 LCI Industries can generate with its current 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 LCI Industries’s debt-to-equity level. The debt-to-equity ratio currently stands at a low 7.65%, meaning the above-average ROE is due to its capacity to produce profit growth without a huge debt burden.
Next Steps:
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. LCI Industries 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. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.
For LCI Industries, there are three pertinent 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.
Valuation: What is LCI Industries 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 LCI Industries is currently mispriced by the market.
Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of LCI Industries? 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.
