With 28.1% ROE in the last year, Grupo Supervielle SA (NYSE:SUPV) appeared more efficient when we look at the industry average of 9.69% ROE. However, we must not ignore the role of leverage, which artificially inflates an ROE, making a poor performance look outstanding. View our latest analysis for Grupo Supervielle S.A
What you must know about ROE
ROE is simply the percentage of past year earnings against the book value of shareholders’ equity, which is the sum of retained earnings and capital raised through equity offerings.Any ROE north of 20%, implying 20 cents return on every dollar invested, is favourable for any investor. But investors seek multiple assets to diversify risk and an industry-specific comparison makes more sense to achieve the goal of choosing the best among a given lot.
Return on Equity = Net Profit ÷ Shareholders Equity
For a company to create value for its shareholders, it must generate an ROE higher than the cost of equity. Unlike debt-holders, there is no predefined return for equity investors. However, an expected return to account for market risk can be arrived at using the Capital Asset Pricing Model. For SUPV, it stands at 10.55% versus its ROE of 28.1%. Using Dupont Analysis, we find out that ROE is composed of three ratios: profit margin, asset turnover, and financial leverage. The method reflects the impact of change in key figures in both the income statement and the balance sheet. The analysis provides a bird’s-eye view on the strengths and weaknesses of the company.
ROE = annual net profit ÷ shareholders’ equity
ROE = (annual net profit ÷ sales) × (sales ÷ assets) × (assets ÷ shareholders’ equity)
ROE = profit margin × asset turnover × financial leverage
A trend of profit growing faster than revenue is indicative of improvement in ROE. While investors should assess the past correlation between them, an assessment of the analysts’ profit and revenue forecast points to the most likely scenario going forward.While the change in a company’s asset turnover ratio is important in assessing the quality of ROE, an equally important aspect is its comparison to the industry average. Grupo Supervielle S.A generated an ROA of 3.1% versus the industry’s 1.03%. For an industry, ROA, which is earnings as a percentage of assets, is a sound representation of asset turnover.
The impact of leverage on ROE is reflected in a company’s debt-equity profile. Rapidly rising debt compared to equity, while profit margin and asset turnover underperform, raises a red flag on the ROE. It’s important as a company can inflate its ROE by consistently increasing debt despite weak operating performance. SUPV’s debt to equity ratio currently stands at 0.81. Investors should be cautious about any sharp change in this ratio, more so if it’s due to increasing debt.
ROE – It’s not just another ratio
On the surface, ROE appears to be a simple profitability ratio indicating the return an investor should expect. However, for a sound investment consideration, it should still appear good when a company’s debt profile, profit-revenue trend, and leverage are considered. What do the analysts think about Grupo Supervielle S.A’s ROE three-years ahead? I recommend you see our latest FREE analysis report to find out!
If you are not interested in SUPV anymore, you can use our free platform to see my list of stocks with Return on Equity over 20%.