Global Self Storage Inc (NASDAQ:SELF) generated a below-average return on equity of 0.87% in the past 12 months, while its industry returned 8.29%. SELF'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 SELF’s performance. Today I will look at how components such as financial leverage can influence ROE which may impact the sustainability of SELF's returns. Check out our latest analysis for Global Self Storage
Breaking down ROE — the mother of all ratios
Return on Equity (ROE) is a measure of SELF’s profit relative to its shareholders’ equity. It essentially shows how much SELF can generate in earnings given the amount of equity it has raised. 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 SELF’s equity capital deployed. Its cost of equity is 8.49%. Given a discrepancy of -7.63% between return and cost, this indicated that SELF may be paying more for its capital than what it’s generating 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:
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 SELF can make from its 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 SELF’s capital structure is. Since ROE can be inflated by excessive debt, we need to examine SELF’s debt-to-equity level. The debt-to-equity ratio currently stands at a low 49.14%, meaning SELF still has headroom to borrow debt to increase profits.
What this means for you:
Are you a shareholder? SELF’s below-industry ROE is disappointing, furthermore, its returns were not even high enough to cover its own cost of equity. However, investors shouldn’t despair since ROE is not inflated by excessive debt, which means SELF still has room to improve shareholder returns by raising debt to fund new investments.
Are you a potential investor? If SELF has been on your watch list for a while, making an investment decision based on ROE alone is unwise. I recommend you do additional fundamental analysis by looking through our most recent infographic report on Global Self Storage to help you make a more informed investment decision. If you are not interested in SELF anymore, you can use our free platform to see our list of stocks with Return on Equity over 20%.
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.