This analysis is intended to introduce important early concepts to people who are starting to invest and want a simplistic look at the return on Albemarle Corporation (NYSE:ALB) stock.
Albemarle Corporation (NYSE:ALB) generated a below-average return on equity of 4.46% in the past 12 months, while its industry returned 13.89%. ALB’s results could indicate a relatively inefficient operation to its peers, and while this may be the case, it is important to understand what ROE is made up of and how it should be interpreted. Knowing these components could change your view on ALB’s performance. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of ALB’s returns. Let me show you what I mean by this. View out our latest analysis for Albemarle
Peeling the layers of ROE – trisecting a company’s profitability
Return on Equity (ROE) weighs Albemarle’s profit against the level of its shareholders’ equity. It essentially shows how much the company can generate in earnings given the amount of equity it has raised. 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 Albemarle, which is 9.15%. Since Albemarle’s return does not cover its cost, with a difference of -4.70%, this means its current use of equity is not efficient and not sustainable. Very simply, Albemarle 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:
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. The other component, asset turnover, illustrates how much revenue Albemarle can make from its asset base. And finally, financial leverage is simply how much of assets are funded by equity, which exhibits how sustainable the company’s capital structure is. Since ROE can be artificially increased through excessive borrowing, we should check Albemarle’s historic debt-to-equity ratio. At 37.43%, Albemarle’s debt-to-equity ratio appears low and indicates that Albemarle still has room to increase leverage and grow its profits.
ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. Albemarle’s ROE is underwhelming relative to the industry average, and its returns were also not strong enough to cover its own cost of equity. However, ROE is not likely to be inflated by excessive debt funding, giving shareholders more conviction in the sustainability of returns, which has headroom to increase further. Although ROE can be a useful metric, it is only a small part of diligent research.
For Albemarle, I’ve put together three key aspects you should look at:
- 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 Albemarle 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 Albemarle is currently mispriced by the market.
- Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Albemarle? 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.