Five Point Holdings LLC (NYSE:FPH) generated a below-average return on equity of 1.27% in the past 12 months, while its industry returned 10.58%. 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 FPH’s past performance. I will take you through how metrics such as financial leverage impact ROE which may affect the overall sustainability of FPH’s returns. View our latest analysis for Five Point Holdings
What you must know about ROE
Return on Equity (ROE) weighs Five Point Holdings’s profit against the level of its shareholders’ equity. An ROE of 1.27% implies $0.01 returned on every $1 invested. 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
Returns are usually compared to costs to measure the efficiency of capital. Five Point Holdings’s cost of equity is 8.79%. This means Five Point Holdings’s returns actually do not cover its own cost of equity, with a discrepancy of -7.52%. This isn’t sustainable as it implies, very simply, that the company 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 reveals how much revenue can be generated from Five Point Holdings’s 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 Five Point Holdings’s historic debt-to-equity ratio. Currently the debt-to-equity ratio stands at a low 34.81%, which means Five Point Holdings still has headroom to take on more leverage in order to increase profits.
ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. Five Point Holdings 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. Although ROE can be a useful metric, it is only a small part of diligent research.
For Five Point Holdings, I’ve compiled 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.
- Future Earnings: How does Five Point Holdings’s growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
- Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Five Point Holdings? 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.