The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want a simplistic look at the return on VSE Corporation (NASDAQ:VSEC) stock.
VSE Corporation (NASDAQ:VSEC) outperformed the Diversified Support Services industry on the basis of its ROE – producing a higher 12.81% relative to the peer average of 12.02% over the past 12 months. On the surface, this looks fantastic since we know that VSEC has made large profits from little equity capital; however, ROE doesn’t tell us if management have borrowed heavily to make this happen. Today, we’ll take a closer look at some factors like financial leverage to see how sustainable VSEC’s ROE is. Check out our latest analysis for VSE
Breaking down Return on Equity
Return on Equity (ROE) is a measure of VSE’s profit relative to its shareholders’ equity. For example, if the company invests $1 in the form of equity, it will generate $0.13 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 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 VSE, which is 8.59%. This means VSE returns enough to cover its own cost of equity, with a buffer of 4.22%. This sustainable practice implies that the company pays less 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:
ROE = profit margin × asset turnover × financial leverage
ROE = (annual net profit ÷ sales) × (sales ÷ assets) × (assets ÷ shareholders’ equity)
ROE = annual net profit ÷ shareholders’ equity
Essentially, profit margin shows how much money the company makes after paying for all its expenses. Asset turnover reveals how much revenue can be generated from VSE’s asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. Since ROE can be inflated by excessive debt, we need to examine VSE’s debt-to-equity level. The debt-to-equity ratio currently stands at a sensible 60.19%, meaning the above-average ROE is due to its capacity to produce profit growth without a huge debt burden.
While ROE is a relatively simple calculation, it can be broken down into different ratios, each telling a different story about the strengths and weaknesses of a company. VSE’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 VSE, I’ve put together three key 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 VSE 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 VSE is currently mispriced by the market.
- Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of VSE? 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.