Yahoo Finance What You Must Know About Anglo-Eastern Plantations Plc’s (LON:AEP) 8.5% ROE
This analysis is intended to introduce important early concepts to people who are starting to invest and want to learn about Return on Equity using a real-life example.
Anglo-Eastern Plantations Plc (LON:AEP) delivered a less impressive 8.5% ROE over the past year, compared to the 9.7% return generated by its industry. 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 AEP’s past performance. Today I will look at how components such as financial leverage can influence ROE which may impact the sustainability of AEP’s returns.
View our latest analysis for Anglo-Eastern Plantations
Peeling the layers of ROE – trisecting a company’s profitability
Return on Equity (ROE) is a measure of Anglo-Eastern Plantations’s profit relative to its shareholders’ equity. For example, if the company invests £1 in the form of equity, it will generate £0.085 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
Returns are usually compared to costs to measure the efficiency of capital. Anglo-Eastern Plantations’s cost of equity is 8.3%. Some of Anglo-Eastern Plantations’s peers may have a higher ROE but its cost of equity could exceed this return, leading to an unsustainable negative discrepancy i.e. the company spends more than it earns. This is not the case for Anglo-Eastern Plantations which is reassuring. 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
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 Anglo-Eastern Plantations 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 the company’s capital structure is. Since ROE can be inflated by excessive debt, we need to examine Anglo-Eastern Plantations’s debt-to-equity level. At 5.5%, Anglo-Eastern Plantations’s debt-to-equity ratio appears low and indicates that Anglo-Eastern Plantations still has room to increase leverage and grow its profits.
Next Steps:
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. Even though Anglo-Eastern Plantations returned below the industry average, its ROE comes in excess of its cost of equity. Also, 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. Although ROE can be a useful metric, it is only a small part of diligent research.
For Anglo-Eastern Plantations, I’ve compiled three important 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.
Valuation: What is Anglo-Eastern Plantations 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 Anglo-Eastern Plantations is currently mispriced by the market.
Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Anglo-Eastern Plantations? 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 past 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. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.
