Yahoo Finance Can The Go-Ahead Group plc’s (LON:GOG) ROE Continue To Surpass The Industry Average?
This article is intended for those of you who are at the beginning of your investing journey and looking to gauge the potential return on investment in The Go-Ahead Group plc (LON:GOG).
The Go-Ahead Group plc (LON:GOG) delivered an ROE of 41.11% over the past 12 months, which is an impressive feat relative to its industry average of 9.88% during the same period. While the impressive ratio tells us that GOG has made significant profits from little equity capital, ROE doesn’t tell us if GOG has borrowed debt to make this happen. In this article, we’ll closely examine some factors like financial leverage to evaluate the sustainability of GOG’s ROE. See our latest analysis for Go-Ahead Group
Breaking down ROE — the mother of all ratios
Return on Equity (ROE) weighs Go-Ahead Group’s profit against the level of 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 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 Go-Ahead Group, which is 8.28%. Since Go-Ahead Group’s return covers its cost in excess of 32.83%, its use of equity capital is efficient and likely to be sustainable. Simply put, Go-Ahead Group pays less 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:
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 Go-Ahead Group can generate with its current 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 financial leverage can artificially inflate ROE, we need to look at how much debt Go-Ahead Group currently has. The debt-to-equity ratio currently stands at a balanced 134.13%, meaning the above-average ROE is due to its capacity to produce profit growth without a huge debt burden.
Next Steps:
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. Go-Ahead Group’s ROE is impressive relative to the industry average and also covers its cost of equity. Its high ROE is not likely to be driven by high debt. Therefore, investors may have more confidence in the sustainability of this level of returns going forward. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.
For Go-Ahead Group, I’ve put together three relevant factors 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.
Valuation: What is Go-Ahead Group 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 Go-Ahead Group is currently mispriced by the market.
Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Go-Ahead Group? 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.
