With An ROE Of 33.24%, Has MedReleaf Corp’s (TSX:LEAF) Management Done A Good Job?
MedReleaf Corp (TSX:LEAF) delivered an ROE of 33.24% over the past 12 months, which is an impressive feat relative to its industry average of 22.27% during the same period. Superficially, this looks great since we know that LEAF has generated big profits with little equity capital; however, ROE doesn’t tell us how much LEAF has borrowed in debt. In this article, we’ll closely examine some factors like financial leverage to evaluate the sustainability of LEAF’s ROE. See our latest analysis for LEAF
What you must know about ROE
Firstly, Return on Equity, or ROE, is simply the percentage of last years’ earning against the book value of shareholders’ equity. For example, if LEAF invests $1 in the form of equity, it will generate $0.33 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 LEAF’s equity capital deployed. Its cost of equity is 17.53%. Since LEAF’s return covers its cost in excess of 15.71%, its use of equity capital is efficient and likely to be sustainable. Simply put, LEAF pays less for its capital than what it generates in return. ROE can be dissected into three distinct 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
The first component is profit margin, which measures how much of sales is retained after the company pays for all its expenses. The other component, asset turnover, illustrates how much revenue LEAF can make from its asset base. And finally, financial leverage is simply how much of assets are funded by equity, which exhibits how sustainable LEAF’s capital structure is. Since ROE can be artificially increased through excessive borrowing, we should check LEAF’s historic debt-to-equity ratio. Currently the debt-to-equity ratio stands at a low 7.33%, which means its above-average ROE is driven by its ability to grow its profit without a significant debt burden.
What this means for you:
Are you a shareholder? LEAF’s ROE is impressive relative to the industry average and also covers 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.
Are you a potential investor? If you are considering investing in LEAF, basing your decision on ROE alone is certainly not sufficient. I recommend you do additional fundamental analysis by looking through our most recent infographic report on MedReleaf to help you make a more informed investment decision. If you are not interested in LEAF anymore, you can use our free platform to see our list of stocks with Return on Equity over 20%.
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.
