The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to begin learning the link between Kewaunee Scientific Corporation (NASDAQ:KEQU)’s return fundamentals and stock market performance.
Kewaunee Scientific Corporation’s (NASDAQ:KEQU) most recent return on equity was a substandard 11.43% relative to its industry performance of 11.63% 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 KEQU’s past performance. Today I will look at how components such as financial leverage can influence ROE which may impact the sustainability of KEQU’s returns. View out our latest analysis for Kewaunee Scientific
Peeling the layers of ROE – trisecting a company’s profitability
Return on Equity (ROE) is a measure of Kewaunee Scientific’s profit relative to its shareholders’ equity. It essentially shows how much the company can generate in earnings given the amount of equity it has raised. 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 measured against cost of equity in order to determine the efficiency of Kewaunee Scientific’s equity capital deployed. Its cost of equity is 8.59%. Kewaunee Scientific’s ROE exceeds its cost by 2.84%, which is a big tick. Some of its peers with higher ROE may face a cost which exceeds returns, which is unsustainable and far less desirable than Kewaunee Scientific’s case of positive discrepancy. 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
The first component is profit margin, which measures how much of sales is retained after the company pays for all its expenses. The other component, asset turnover, illustrates how much revenue Kewaunee Scientific can make from its 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 inflated by excessive debt, we need to examine Kewaunee Scientific’s debt-to-equity level. Currently the debt-to-equity ratio stands at a low 16.27%, which means Kewaunee Scientific 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. Although Kewaunee Scientific’s ROE is underwhelming relative to the industry average, its returns are high enough to cover the cost of equity. Its appropriate level of leverage means investors can be more confident in the sustainability of Kewaunee Scientific’s return with a possible increase should the company decide to increase its debt levels. Although ROE can be a useful metric, it is only a small part of diligent research.
For Kewaunee Scientific, there are three pertinent factors 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.
- Valuation: What is Kewaunee Scientific 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 Kewaunee Scientific is currently mispriced by the market.
- Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Kewaunee Scientific? 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.