Hyster-Yale Materials Handling Inc (NYSE:HY) delivered a less impressive 8.54% ROE over the past year, compared to the 11.27% return generated by its industry. Though HY’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 HY’s below-average returns. I will take you through how metrics such as financial leverage impact ROE which may affect the overall sustainability of HY’s returns. See our latest analysis for Hyster-Yale Materials Handling
Breaking down Return on Equity
Return on Equity (ROE) is a measure of Hyster-Yale Materials Handling’s profit relative to its shareholders’ equity. For example, if the company invests $1 in the form of equity, it will generate $0.09 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 Hyster-Yale Materials Handling, which is 9.90%. Since Hyster-Yale Materials Handling’s return does not cover its cost, with a difference of -1.36%, this means its current use of equity is not efficient and not sustainable. Very simply, Hyster-Yale Materials Handling pays more for its capital than what it generates in return. ROE can be broken down into three different 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
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 reveals how much revenue can be generated from Hyster-Yale Materials Handling’s 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 Hyster-Yale Materials Handling’s historic debt-to-equity ratio. Currently the debt-to-equity ratio stands at a reasonable 50.82%, which means its ROE is driven by its ability to grow its profit without a significant debt burden.
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. Hyster-Yale Materials Handling 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 Hyster-Yale Materials Handling, I’ve put together three essential factors you should further research:
- 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 Hyster-Yale Materials Handling 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 Hyster-Yale Materials Handling is currently mispriced by the market.
- Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Hyster-Yale Materials Handling? 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.