Why Flexsteel Industries Inc’s (NASDAQ:FLXS) ROE Of 8.90% Does Not Tell The Whole Story
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 Flexsteel Industries Inc (NASDAQ:FLXS) stock.
Flexsteel Industries Inc’s (NASDAQ:FLXS) most recent return on equity was a substandard 8.90% relative to its industry performance of 13.03% over the past year. 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 FLXS’s past performance. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of FLXS’s returns. Let me show you what I mean by this. View out our latest analysis for Flexsteel Industries
Breaking down Return on Equity
Return on Equity (ROE) is a measure of Flexsteel Industries’s profit relative to its shareholders’ equity. For example, if the company invests $1 in the form of equity, it will generate $0.089 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 measured against cost of equity in order to determine the efficiency of Flexsteel Industries’s equity capital deployed. Its cost of equity is 9.20%. This means Flexsteel Industries’s returns actually do not cover its own cost of equity, with a discrepancy of -0.30%. 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 split up into three useful 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. Asset turnover shows how much revenue Flexsteel Industries can generate with its current asset base. Finally, financial leverage will be our main focus today. It shows how much of assets are funded by equity and can show how sustainable the company’s capital structure is. Since ROE can be artificially increased through excessive borrowing, we should check Flexsteel Industries’s historic debt-to-equity ratio. Currently, Flexsteel Industries has no debt which means its returns are driven purely by equity capital. This could explain why Flexsteel Industries’s’ ROE is lower than its industry peers, most of which may have some degree of debt in its business.
Next Steps:
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. Flexsteel Industries’s ROE is underwhelming relative to the industry average, and its returns were also not strong enough to cover its own cost of equity. Although, its appropriate level of leverage means investors can be more confident in the sustainability of Flexsteel Industries’s return with a possible increase should the company decide to increase its debt levels. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.
For Flexsteel Industries, I’ve put together three key 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.
Future Earnings: How does Flexsteel Industries’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 Flexsteel Industries? 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.
