SW Umwelttechnik Stoiser & Wolschner AG (WBAG:SWUT) outperformed the construction and engineering industry on the basis of its ROE – producing a higher 24.45% relative to the peer average of 10.67% over the past 12 months. However, whether this above-industry ROE is actually impressive depends on if it can be maintained. This can be measured by looking at the company’s financial leverage. With more debt, SWUT can invest even more and earn more money, thus pushing up its returns. However, ROE only measures returns against equity, not debt. This can be distorted, so let’s take a look at it further. View our latest analysis for SW Umwelttechnik Stoiser & Wolschner
What you must know about ROE
Return on Equity (ROE) is a measure of SW Umwelttechnik Stoiser & Wolschner’s profit relative to its shareholders’ equity. For example, if the company invests €1 in the form of equity, it will generate €0.24 in earnings from this. Investors seeking to maximise their return in the Construction and Engineering industry may want to choose the highest returning stock. But this can be misleading as each company has different costs of equity and also varying debt levels, which could artificially push up ROE whilst accumulating high interest expense.
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 SW Umwelttechnik Stoiser & Wolschner, which is 19.13%. Since SW Umwelttechnik Stoiser & Wolschner’s return covers its cost in excess of 5.33%, its use of equity capital is efficient and likely to be sustainable. Simply put, SW Umwelttechnik Stoiser & Wolschner pays less for its capital than what it generates in return. ROE can be split up into three useful ratios: net profit margin, asset turnover, and financial leverage. This is called the 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. The other component, asset turnover, illustrates how much revenue SW Umwelttechnik Stoiser & Wolschner 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. ROE can be inflated by disproportionately high levels of debt. This is also unsustainable due to the high interest cost that the company will also incur. Thus, we should look at SW Umwelttechnik Stoiser & Wolschner’s debt-to-equity ratio to examine sustainability of its returns. The most recent ratio is greater than 2.5 times which is very high, indicating SW Umwelttechnik Stoiser & Wolschner’s above-average ROE is generated by its significant leverage levels and its ability to grow profit hinges on a substantial debt burden.
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. SW Umwelttechnik Stoiser & Wolschner exhibits a strong ROE against its peers, as well as sufficient returns to cover its cost of equity. Its high debt level means its strong ROE may be driven by debt funding which raises concerns over the sustainability of SW Umwelttechnik Stoiser & Wolschner’s returns. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.
For SW Umwelttechnik Stoiser & Wolschner, I’ve put together three relevant aspects you should further examine:
- 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 SW Umwelttechnik Stoiser & Wolschner 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 SW Umwelttechnik Stoiser & Wolschner is currently mispriced by the market.
- Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of SW Umwelttechnik Stoiser & Wolschner? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!