With An ROE Of 8.28%, Has STMicroelectronics NV’s (EPA:STM) Management Done Well?
This article is intended for those of you who are at the beginning of your investing journey and want to start learning about core concepts of fundamental analysis on practical examples from today’s market.
STMicroelectronics NV (EPA:STM) delivered a less impressive 8.28% ROE over the past year, compared to the 9.18% return generated by its industry. Though STM’s recent performance is underwhelming, it is useful to understand what ROE is made up of and how it should be interpreted. Knowing these components can change your views on STM’s below-average returns. I will take you through how metrics such as financial leverage impact ROE which may affect the overall sustainability of STM’s returns.
View our latest analysis for STMicroelectronics
Breaking down ROE — the mother of all ratios
Return on Equity (ROE) is a measure of STMicroelectronics’s profit relative to its shareholders’ equity. It essentially shows how much the company 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
ROE is measured against cost of equity in order to determine the efficiency of STMicroelectronics’s equity capital deployed. Its cost of equity is 10.05%. This means STMicroelectronics’s returns actually do not cover its own cost of equity, with a discrepancy of -1.78%. 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:
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 shows how much revenue STMicroelectronics can generate with its current 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 the company’s capital structure is. Since ROE can be artificially increased through excessive borrowing, we should check STMicroelectronics’s historic debt-to-equity ratio. Currently the debt-to-equity ratio stands at a low 30.35%, which means STMicroelectronics still has headroom to take on more leverage in order to increase profits.
Next Steps:
ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. STMicroelectronics exhibits a weak ROE against its peers, as well as insufficient levels to cover its own cost of equity this year. Although, its appropriate level of leverage means investors can be more confident in the sustainability of STMicroelectronics’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 STMicroelectronics, I’ve put together three important factors 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 STMicroelectronics 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 STMicroelectronics is currently mispriced by the market.
Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of STMicroelectronics? 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 past 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. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.
