Yahoo Finance Stagecoach Group plc (LON:SGC): Can It Deliver A Superior ROE To The Industry?
This analysis is intended to introduce important early concepts to people who are starting to invest and want a simplistic look at the return on Stagecoach Group plc (LON:SGC) stock.
Stagecoach Group plc (LON:SGC) delivered a less impressive 8.60% ROE over the past year, compared to the 9.88% return generated by its industry. Though SGC’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 SGC’s below-average returns. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of SGC’s returns. Let me show you what I mean by this. View out our latest analysis for Stagecoach Group
Peeling the layers of ROE – trisecting a company’s profitability
Return on Equity (ROE) weighs Stagecoach Group’s profit against the level of its shareholders’ equity. For example, if the company invests £1 in the form of equity, it will generate £0.086 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
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 Stagecoach Group, which is 8.28%. Some of Stagecoach Group’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 Stagecoach Group 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
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 Stagecoach Group’s 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 Stagecoach Group’s historic debt-to-equity ratio. At over 2.5 times, Stagecoach Group’s debt-to-equity ratio is very high and indicates the below-average ROE is already being generated by significant leverage levels.
Next Steps:
ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. While Stagecoach Group exhibits a weak ROE against its peers, its returns are sufficient enough to cover its cost of equity. However, with debt capital in excess of equity, ROE may already be inflated by the use of debt funding, raising questions over the possibility of further decline in the company’s returns. Although ROE can be a useful metric, it is only a small part of diligent research.
For Stagecoach 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 Stagecoach 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 Stagecoach Group is currently mispriced by the market.
Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Stagecoach 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.
