With An ROE Of 6.16%, Has Electrum Special Acquisition Corporation’s (ELEC) Management Done A Good Job?
Electrum Special Acquisition Corporation (NASDAQ:ELEC) delivered a less impressive 6.16% ROE over the past year, compared to the 11.19% return generated by its industry. ELEC’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 ELEC’s performance. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of ELEC’s returns. Let me show you what I mean by this. View our latest analysis for Electrum Special Acquisition
Peeling the layers of ROE – trisecting a company’s profitability
Return on Equity (ROE) is a measure of ELEC’s profit relative to its shareholders’ equity. For example, if ELEC invests $1 in the form of equity, it will generate $0.06 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
Returns are usually compared to costs to measure the efficiency of capital. ELEC’s cost of equity is 8.62%. This means ELEC’s returns actually do not cover its own cost of equity, with a discrepancy of -2.45%. 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 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
Basically, profit margin measures how much of revenue trickles down into earnings which illustrates how efficient ELEC is with its cost management. Asset turnover reveals how much revenue can be generated from ELEC’s asset base. And finally, financial leverage is simply how much of assets are funded by equity, which exhibits how sustainable ELEC’s capital structure is. Since financial leverage can artificially inflate ROE, we need to look at how much debt ELEC currently has. At 32.17%, ELEC’s debt-to-equity ratio appears low and indicates that ELEC still has room to increase leverage and grow its profits.
What this means for you:
Are you a shareholder? ELEC exhibits a weak ROE against its peers, as well as insufficient levels to cover its own cost of equity this year. However, investors shouldn’t despair since ROE is not inflated by excessive debt, which means ELEC 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 ELEC, 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 Electrum Special Acquisition 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.
