I am writing today to help inform people who are new to the stock market and want to begin learning the link between Eisen- und Hüttenwerke AG (FRA:EIS)’s return fundamentals and stock market performance.
Eisen- und Hüttenwerke AG’s (FRA:EIS) most recent return on equity was a substandard 8.65% relative to its industry performance of 10.81% over the past year. Though EIS’s recent performance is underwhelming, it is useful to understand what ROE is made up of and how it should be interpreted. Knowing these components can change your views on EIS’s below-average returns. I will take you through how metrics such as financial leverage impact ROE which may affect the overall sustainability of EIS’s returns. Check out our latest analysis for Eisen- und Hüttenwerke
Breaking down Return on Equity
Return on Equity (ROE) weighs Eisen- und Hüttenwerke’s profit against the level of its shareholders’ equity. For example, if the company invests €1 in the form of equity, it will generate €0.086 in earnings from this. 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 Eisen- und Hüttenwerke, which is 10.23%. Since Eisen- und Hüttenwerke’s return does not cover its cost, with a difference of -1.58%, this means its current use of equity is not efficient and not sustainable. Very simply, Eisen- und Hüttenwerke pays more for its capital than what it generates 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
Essentially, profit margin shows how much money the company makes after paying for all its expenses. Asset turnover shows how much revenue Eisen- und Hüttenwerke can generate with its current 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 financial leverage can artificially inflate ROE, we need to look at how much debt Eisen- und Hüttenwerke currently has. Currently, Eisen- und Hüttenwerke has no debt which means its returns are driven purely by equity capital. This could explain why Eisen- und Hüttenwerke’s’ ROE is lower than its industry peers, most of which may have some degree of debt in its business.
ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. Eisen- und Hüttenwerke’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. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.
For Eisen- und Hüttenwerke, there are three essential 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 Eisen- und Hüttenwerke 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 Eisen- und Hüttenwerke is currently mispriced by the market.
- Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Eisen- und Hüttenwerke? 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.