Why Carecom Inc (NYSE:CRCM) Delivered An Inferior ROE Compared To The Industry
This article is intended for those of you who are at the beginning of your investing journey and want a simplistic look at the return on Carecom Inc (NYSE:CRCM) stock.
Carecom Inc (NYSE:CRCM) generated a below-average return on equity of 8.49% in the past 12 months, while its industry returned 12.67%. 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 CRCM’s past performance. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of CRCM’s returns. Let me show you what I mean by this. View out our latest analysis for Care.com
Breaking down ROE — the mother of all ratios
Return on Equity (ROE) is a measure of Care.com’s profit relative to its shareholders’ equity. An ROE of 8.49% implies $0.085 returned on every $1 invested. 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 Care.com, which is 11.98%. Given a discrepancy of -3.49% between return and cost, this indicated that Care.com 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:
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. The other component, asset turnover, illustrates how much revenue Care.com can make from its 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 Care.com’s debt-to-equity level. Currently, Care.com has no debt which means its returns are driven purely by equity capital. This could explain why Care.com’s’ ROE is lower than its industry peers, most of which may have some degree of debt in its business.
Next Steps:
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. Care.com exhibits a weak ROE against its peers, as well as insufficient levels to cover its own cost of equity this year. 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. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.
For Care.com, I’ve compiled three relevant aspects 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 Care.com 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 Care.com is currently mispriced by the market.
Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Care.com? 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.