Is Smurfit Kappa Group plc’s (ISE:SK3) 15.91% ROE Strong Compared To Its Industry?
Smurfit Kappa Group plc (ISE:SK3) outperformed the Paper Packaging industry on the basis of its ROE – producing a higher 15.91% relative to the peer average of 12.06% over the past 12 months. Superficially, this looks great since we know that SK3 has generated big profits with little equity capital; however, ROE doesn’t tell us how much SK3 has borrowed in debt. We’ll take a closer look today at factors like financial leverage to determine whether SK3’s ROE is actually sustainable. View our latest analysis for Smurfit Kappa Group
What you must know about ROE
Return on Equity (ROE) weighs Smurfit Kappa Group’s profit against the level of its shareholders’ equity. An ROE of 15.91% implies €0.16 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 assessed against cost of equity, which is measured using the Capital Asset Pricing Model (CAPM) – but let’s not dive into the details of that today. For now, let’s just look at the cost of equity number for Smurfit Kappa Group, which is 10.74%. Given a positive discrepancy of 5.17% between return and cost, this indicates that Smurfit Kappa Group pays less for its capital than what it generates in return, which is a sign of capital efficiency. 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
Basically, profit margin measures how much of revenue trickles down into earnings which illustrates how efficient the business is with its cost management. Asset turnover shows how much revenue Smurfit Kappa Group can generate with its current asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. Since financial leverage can artificially inflate ROE, we need to look at how much debt Smurfit Kappa Group currently has. At 125.76%, Smurfit Kappa Group’s debt-to-equity ratio appears balanced and indicates the above-average ROE is generated from its capacity to increase profit without a large debt burden.
Next Steps:
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. Smurfit Kappa Group exhibits a strong ROE against its peers, as well as sufficient returns to cover its cost of equity. ROE is not likely to be inflated by excessive debt funding, giving shareholders more conviction in the sustainability of high returns. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.
For Smurfit Kappa Group, I’ve compiled three essential aspects you should further research:
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 Smurfit Kappa Group 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 Smurfit Kappa Group is currently mispriced by the market.
Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Smurfit Kappa Group? 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.
