Gilat Satellite Networks Ltd (NASDAQ:GILT) delivered a less impressive 3.78% ROE over the past year, compared to the 9.46% return generated by its industry. GILT’s results could indicate a relatively inefficient operation to its peers, and while this may be the case, it is important to understand what ROE is made up of and how it should be interpreted. Knowing these components could change your view on GILT’s performance. I will take you through how metrics such as financial leverage impact ROE which may affect the overall sustainability of GILT’s returns. See our latest analysis for GILT
Peeling the layers of ROE – trisecting a company’s profitability
Return on Equity (ROE) weighs GILT’s profit against the level of its shareholders’ equity. An ROE of 3.78% implies $0.04 returned on every $1 invested. While a higher ROE is preferred in most cases, there are several other factors we should consider before drawing any conclusions.
Return on Equity = Net Profit ÷ Shareholders Equity
ROE is measured against cost of equity in order to determine the efficiency of GILT’s equity capital deployed. Its cost of equity is 10.16%. This means GILT’s returns actually do not cover its own cost of equity, with a discrepancy of -6.39%. This isn’t sustainable as it implies, very simply, that the company pays more 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 GILT is with its cost management. The other component, asset turnover, illustrates how much revenue GILT can make from its 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 GILT’s capital structure is. Since financial leverage can artificially inflate ROE, we need to look at how much debt GILT currently has. The debt-to-equity ratio currently stands at a low 8.00%, meaning GILT still has headroom to borrow debt to increase profits.
What this means for you:
Are you a shareholder? GILT’s below-industry ROE is disappointing, furthermore, its returns were not even high enough to cover its own cost of equity. However, investors shouldn’t despair since ROE is not inflated by excessive debt, which means GILT still has room to improve shareholder returns by raising debt to fund new investments. 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 you are considering investing in GILT, looking at ROE on its own is not enough to make a well-informed decision. I recommend you do additional fundamental analysis by looking through our most recent infographic report on Gilat Satellite Networks 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.