With An ROE Of 25.16%, Has Ted Baker PLC’s (LSE:TED) Management Done A Good Job?
Ted Baker PLC (LSE:TED) outperformed the Apparel, Accessories and Luxury Goods industry on the basis of its ROE – producing a higher 25.16% relative to the peer average of 24.72% over the past 12 months. On the surface, this looks fantastic since we know that TED has made large profits from little equity capital; however, ROE doesn’t tell us if management have borrowed heavily to make this happen. In this article, we’ll closely examine some factors like financial leverage to evaluate the sustainability of TED’s ROE. View our latest analysis for Ted Baker
What you must know about ROE
Return on Equity (ROE) weighs TED’s profit against the level of its shareholders’ equity. It essentially shows how much TED can generate in earnings given the amount of equity it has raised. 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
Returns are usually compared to costs to measure the efficiency of capital. TED’s cost of equity is 8.59%. This means TED returns enough to cover its own cost of equity, with a buffer of 16.57%. This sustainable practice implies that the company 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:
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 TED is with its cost management. Asset turnover reveals how much revenue can be generated from TED’s asset base. Finally, financial leverage will be our main focus today. It shows how much of assets are funded by equity and can show how sustainable TED’s capital structure is. Since financial leverage can artificially inflate ROE, we need to look at how much debt TED currently has. The debt-to-equity ratio currently stands at a sensible 67.96%, meaning the above-average ROE is due to its capacity to produce profit growth without a huge debt burden.
What this means for you:
Are you a shareholder? TED’s above-industry ROE is encouraging, and is also in excess of its cost of equity. Since its high ROE is not likely driven by high debt, it might be a good time to top up on your current holdings if your fundamental research reaffirms this analysis. If you’re looking for new ideas for high-returning stocks, you should take a look at our free platform to see the list of stocks with Return on Equity over 20%.
Are you a potential investor? If TED has been on your watch list for a while, making an investment decision based on ROE alone is unwise. I recommend you do additional fundamental analysis by looking through our most recent infographic report on Ted Baker to help you make a more informed investment decision.
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.
