Yahoo Finance How Spirax-Sarco Engineering plc (LON:SPX) Delivered A Better ROE Than Its Industry
Spirax-Sarco Engineering plc (LSE:SPX) delivered an ROE of 25.91% over the past 12 months, which is an impressive feat relative to its industry average of 11.81% during the same period. Superficially, this looks great since we know that SPX has generated big profits with little equity capital; however, ROE doesn’t tell us how much SPX has borrowed in debt. Today, we’ll take a closer look at some factors like financial leverage to see how sustainable SPX’s ROE is. View our latest analysis for Spirax-Sarco Engineering
What you must know about ROE
Firstly, Return on Equity, or ROE, is simply the percentage of last years’ earning against the book value of shareholders’ equity. For example, if the company invests £1 in the form of equity, it will generate £0.26 in earnings from this. 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 measured against cost of equity in order to determine the efficiency of Spirax-Sarco Engineering’s equity capital deployed. Its cost of equity is 8.96%. Given a positive discrepancy of 16.94% between return and cost, this indicates that Spirax-Sarco Engineering pays less for its capital than what it generates in return, which is a sign of capital efficiency. 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
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 reveals how much revenue can be generated from Spirax-Sarco Engineering’s asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. Since ROE can be inflated by excessive debt, we need to examine Spirax-Sarco Engineering’s debt-to-equity level. Currently the debt-to-equity ratio stands at a reasonable 86.25%, 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. Spirax-Sarco Engineering’s ROE is impressive relative to the industry average and also covers 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 Spirax-Sarco Engineering, there are three pertinent 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 Spirax-Sarco Engineering 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 Spirax-Sarco Engineering is currently mispriced by the market.
Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Spirax-Sarco Engineering? 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.
