Zespól Elektrowni Patnów-Adamów-Konin SA. (WSE:ZEP) generated a below-average return on equity of 4.98% in the past 12 months, while its industry returned 7.43%. An investor may attribute an inferior ROE to a relatively inefficient performance, and whilst this can often be the case, knowing the nuts and bolts of the ROE calculation may change that perspective and give you a deeper insight into ZEP’s past performance. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of ZEP’s returns. Let me show you what I mean by this. See our latest analysis for Zespól Elektrowni Patnów-Adamów-Konin
Breaking down Return on Equity
Return on Equity (ROE) is a measure of Zespól Elektrowni Patnów-Adamów-Konin’s profit relative to its shareholders’ equity. For example, if the company invests PLN1 in the form of equity, it will generate PLN0.05 in earnings from this. 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
ROE is measured against cost of equity in order to determine the efficiency of Zespól Elektrowni Patnów-Adamów-Konin’s equity capital deployed. Its cost of equity is 9.61%. Given a discrepancy of -4.64% between return and cost, this indicated that Zespól Elektrowni Patnów-Adamów-Konin may be paying more for its capital than what it’s generating in return. ROE can be dissected into three distinct 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
The first component is profit margin, which measures how much of sales is retained after the company pays for all its expenses. Asset turnover reveals how much revenue can be generated from Zespól Elektrowni Patnów-Adamów-Konin’s asset base. And finally, financial leverage is simply how much of assets are funded by equity, which exhibits how sustainable the company’s capital structure is. Since financial leverage can artificially inflate ROE, we need to look at how much debt Zespól Elektrowni Patnów-Adamów-Konin currently has. The debt-to-equity ratio currently stands at a low 27.40%, meaning Zespól Elektrowni Patnów-Adamów-Konin still has headroom to borrow debt to increase profits.
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. Zespól Elektrowni Patnów-Adamów-Konin’s below-industry ROE is disappointing, furthermore, its returns were not even high enough to cover its own cost of equity. Although, its appropriate level of leverage means investors can be more confident in the sustainability of Zespól Elektrowni Patnów-Adamów-Konin’s return with a possible increase should the company decide to increase its debt levels. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.
For Zespól Elektrowni Patnów-Adamów-Konin, there are three key aspects you should further examine:
- 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 Zespól Elektrowni Patnów-Adamów-Konin 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 Zespól Elektrowni Patnów-Adamów-Konin is currently mispriced by the market.
- Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Zespól Elektrowni Patnów-Adamów-Konin? 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.