Yahoo Finance Why BAUER Aktiengesellschaft’s (ETR:B5A) ROE Of 1.2% Does Not Tell The Whole Story
I am writing today to help inform people who are new to the stock market and want to learn about Return on Equity using a real-life example.
BAUER Aktiengesellschaft (ETR:B5A) delivered a less impressive 1.2% ROE over the past year, compared to the 8.1% return generated by its industry. 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 B5A’s past performance. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of B5A’s returns. Let me show you what I mean by this.
View our latest analysis for BAUER
Breaking down ROE — the mother of all ratios
Return on Equity (ROE) is a measure of BAUER’s profit relative to its shareholders’ equity. For example, if the company invests €1 in the form of equity, it will generate €0.012 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 measured against cost of equity in order to determine the efficiency of BAUER’s equity capital deployed. Its cost of equity is 17.2%. This means BAUER’s returns actually do not cover its own cost of equity, with a discrepancy of -16.0%. This isn’t sustainable as it implies, very simply, that the company pays more for its capital than what it generates in return. 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
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 BAUER 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 ROE can be artificially increased through excessive borrowing, we should check BAUER’s historic debt-to-equity ratio. At 173%, BAUER’s debt-to-equity ratio appears relatively 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. BAUER exhibits a weak ROE against its peers, as well as insufficient levels to cover its own cost of equity this year. Also, 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. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.
For BAUER, there are three relevant 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 BAUER 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 BAUER is currently mispriced by the market.
Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of BAUER? 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.
