Yahoo Finance With An ROE Of 6.21%, Has STMicroelectronics NV.’s (EPA:STM) Management Done Well?
STMicroelectronics NV.’s (ENXTPA:STM) most recent return on equity was a substandard 6.21% relative to its industry performance of 13.40% over the past year. Though STM’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 STM’s below-average returns. Today I will look at how components such as financial leverage can influence ROE which may impact the sustainability of STM’s returns. View our latest analysis for STMicroelectronics
Breaking down ROE — the mother of all ratios
Firstly, Return on Equity, or ROE, is simply the percentage of last years’ earning against the book value of shareholders’ equity. An ROE of 6.21% implies €0.06 returned on every €1 invested. Generally speaking, a higher ROE is preferred; however, there are other factors we must also consider before making any conclusions.
Return on Equity = Net Profit ÷ Shareholders Equity
ROE is measured against cost of equity in order to determine the efficiency of STMicroelectronics’s equity capital deployed. Its cost of equity is 9.37%. Since STMicroelectronics’s return does not cover its cost, with a difference of -3.16%, this means its current use of equity is not efficient and not sustainable. Very simply, STMicroelectronics pays more for its capital than what it generates in return. ROE can be split up into three useful 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. Asset turnover shows how much revenue STMicroelectronics can generate with its current asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. Since ROE can be artificially increased through excessive borrowing, we should check STMicroelectronics’s historic debt-to-equity ratio. Currently the debt-to-equity ratio stands at a low 29.68%, which means STMicroelectronics still has headroom to take on more leverage in order to increase profits.
Next Steps:
ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. STMicroelectronics exhibits a weak ROE against its peers, as well as insufficient levels to cover its own cost of equity this year. Although, its appropriate level of leverage means investors can be more confident in the sustainability of STMicroelectronics’s return with a possible increase should the company decide to increase its debt levels. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.
For STMicroelectronics, there are three fundamental 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 STMicroelectronics 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 STMicroelectronics is currently mispriced by the market.
Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of STMicroelectronics? 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.
