How Universal Forest Products Inc (NASDAQ:UFPI) Delivered A Better ROE Than Its Industry
This analysis is intended to introduce important early concepts to people who are starting to invest and want to learn about Return on Equity using a real-life example.
Universal Forest Products Inc (NASDAQ:UFPI) outperformed the Building Products industry on the basis of its ROE – producing a higher 14.0% relative to the peer average of 13.4% over the past 12 months. Superficially, this looks great since we know that UFPI has generated big profits with little equity capital; however, ROE doesn’t tell us how much UFPI has borrowed in debt. In this article, we’ll closely examine some factors like financial leverage to evaluate the sustainability of UFPI’s ROE.
View our latest analysis for Universal Forest Products
Breaking down ROE — the mother of all ratios
Return on Equity (ROE) weighs Universal Forest Products’s profit against the level of its shareholders’ equity. For example, if the company invests $1 in the form of equity, it will generate $0.14 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
Returns are usually compared to costs to measure the efficiency of capital. Universal Forest Products’s cost of equity is 11.6%. This means Universal Forest Products returns enough to cover its own cost of equity, with a buffer of 2.4%. This sustainable practice implies that the company pays less 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 the business is with its cost management. Asset turnover shows how much revenue Universal Forest Products 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 inflated by excessive debt, we need to examine Universal Forest Products’s debt-to-equity level. The debt-to-equity ratio currently stands at a low 29.6%, meaning the above-average ROE is due to its capacity to produce profit growth without a huge debt burden.
Next Steps:
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. Universal Forest Products’s above-industry ROE is encouraging, and is also in excess of 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 Universal Forest Products, I’ve put together three relevant 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 Universal Forest Products 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 Universal Forest Products is currently mispriced by the market.
Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Universal Forest Products? 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.
