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Will Vossloh AG (FRA:VOS) Continue To Underperform Its Industry?

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.

Vossloh AG’s (FRA:VOS) most recent return on equity was a substandard 4.58% relative to its industry performance of 12.12% over the past year. 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 VOS’s past performance. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of VOS’s returns. Let me show you what I mean by this.

Check out our latest analysis for Vossloh

Breaking down ROE — the mother of all ratios

Return on Equity (ROE) is a measure of Vossloh’s profit relative to its shareholders’ equity. An ROE of 4.58% implies €0.046 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.

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Return on Equity = Net Profit ÷ Shareholders Equity

Returns are usually compared to costs to measure the efficiency of capital. Vossloh’s cost of equity is 11.11%. Since Vossloh’s return does not cover its cost, with a difference of -6.53%, this means its current use of equity is not efficient and not sustainable. Very simply, Vossloh pays more 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

DB:VOS Last Perf August 23rd 18
DB:VOS Last Perf August 23rd 18

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 Vossloh’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 Vossloh’s historic debt-to-equity ratio. Currently the debt-to-equity ratio stands at a reasonable 60.33%, which means its ROE is driven by its ability to grow its profit without a significant debt burden.

DB:VOS Historical Debt August 23rd 18
DB:VOS Historical Debt August 23rd 18

Next Steps:

While ROE is a relatively simple calculation, it can be broken down into different ratios, each telling a different story about the strengths and weaknesses of a company. Vossloh’s ROE is underwhelming relative to the industry average, and its returns were also not strong enough to cover its own cost of equity. However, 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 Vossloh, I’ve put together three important aspects you should further research:

  1. 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.

  2. Valuation: What is Vossloh 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 Vossloh is currently mispriced by the market.

  3. Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Vossloh? 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.