Yahoo Finance Why Vodafone Group Plc (LON:VOD) May Not Be As Efficient As Its Industry
I am writing today to help inform people who are new to the stock market and want a simplistic look at the return on Vodafone Group Plc (LON:VOD) stock.
Vodafone Group Plc’s (LON:VOD) most recent return on equity was a substandard 6.93% relative to its industry performance of 12.71% 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 VOD’s past performance. I will take you through how metrics such as financial leverage impact ROE which may affect the overall sustainability of VOD’s returns. Check out our latest analysis for Vodafone Group
Breaking down ROE — the mother of all ratios
Return on Equity (ROE) weighs Vodafone Group’s profit against the level of its shareholders’ equity. It essentially shows how much the company can generate in earnings given the amount of equity it has raised. 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 Vodafone Group, which is 8.73%. Since Vodafone Group’s return does not cover its cost, with a difference of -1.80%, this means its current use of equity is not efficient and not sustainable. Very simply, Vodafone Group 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
The first component is profit margin, which measures how much of sales is retained after the company pays for all its expenses. The other component, asset turnover, illustrates how much revenue Vodafone Group can make from its asset base. And finally, financial leverage is simply how much of assets are funded by equity, which exhibits how sustainable the company’s capital structure is. Since ROE can be artificially increased through excessive borrowing, we should check Vodafone Group’s historic debt-to-equity ratio. The debt-to-equity ratio currently stands at a sensible 66.34%, meaning the ROE is a result of its capacity to produce profit growth without a huge debt burden.
Next Steps:
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. Vodafone Group’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 Vodafone Group, I’ve put together three essential 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 Vodafone 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 Vodafone Group is currently mispriced by the market.
Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Vodafone 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.