Tantech Holdings Ltd (NASDAQ:TANH) generated a below-average return on equity of 6.01% in the past 12 months, while its industry returned 13.90%. 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 TANH’s past performance. Today I will look at how components such as financial leverage can influence ROE which may impact the sustainability of TANH’s returns. Check out our latest analysis for Tantech Holdings
Breaking down ROE — the mother of all ratios
Return on Equity (ROE) weighs Tantech Holdings’s profit against the level of its shareholders’ equity. For example, if the company invests $1 in the form of equity, it will generate $0.06 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 Tantech Holdings’s equity capital deployed. Its cost of equity is 8.83%. Given a discrepancy of -2.82% between return and cost, this indicated that Tantech Holdings 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 Tantech Holdings’s 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 inflated by excessive debt, we need to examine Tantech Holdings’s debt-to-equity level. The debt-to-equity ratio currently stands at a low 11.56%, meaning Tantech Holdings still has headroom to borrow debt to increase profits.
What this means for you:
Are you a shareholder? TANH’s ROE is underwhelming relative to the industry average, and its returns were also not strong enough to cover its own cost of equity. Since its existing ROE is not fuelled by unsustainable debt, investors shouldn’t give up as TANH still has capacity to improve shareholder returns by borrowing to invest in new projects in the future. 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 TANH has been on your watch list for a while, making an investment decision based on ROE alone is unwise. I recommend you do additional fundamental analysis by looking through our most recent infographic report on Tantech Holdings 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.