Yahoo Finance With An ROE Of 23.92%, Has IMI plc’s (LON:IMI) Management Done Well?
With an ROE of 23.92%, IMI plc (LSE:IMI) outpaced its own industry which delivered a less exciting 11.87% over the past year. Superficially, this looks great since we know that IMI has generated big profits with little equity capital; however, ROE doesn’t tell us how much IMI has borrowed in debt. In this article, we’ll closely examine some factors like financial leverage to evaluate the sustainability of IMI’s ROE. View our latest analysis for IMI
Breaking down ROE — the mother of all ratios
Return on Equity (ROE) is a measure of IMI’s profit relative to its shareholders’ equity. An ROE of 23.92% implies £0.24 returned on every £1 invested. 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 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 IMI, which is 6.30%. Since IMI’s return covers its cost in excess of 17.62%, its use of equity capital is efficient and likely to be sustainable. Simply put, IMI pays less 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:
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 IMI 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 financial leverage can artificially inflate ROE, we need to look at how much debt IMI currently has. Currently the debt-to-equity ratio stands at a reasonable 59.90%, which means its above-average ROE is driven by its ability to grow its profit without a significant debt burden.
Next Steps:
ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. IMI exhibits a strong ROE against its peers, as well as sufficient returns to cover its cost of equity. ROE is not likely to be inflated by excessive debt funding, giving shareholders more conviction in the sustainability of high returns. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.
For IMI, I’ve put together three essential 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 IMI 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 IMI is currently mispriced by the market.
Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of IMI? 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.
