Will Murray Cod Australia Limited (ASX:MCA) Continue To Underperform Its Industry?

Murray Cod Australia Limited (ASX:MCA) generated a below-average return on equity of 0.20% in the past 12 months, while its industry returned 9.72%. MCA's results could indicate a relatively inefficient operation to its peers, and while this may be the case, it is important to understand what ROE is made up of and how it should be interpreted. Knowing these components could change your view on MCA’s performance. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of MCA's returns. Let me show you what I mean by this. View our latest analysis for Murray Cod Australia

Breaking down Return on Equity

Return on Equity (ROE) is a measure of Murray Cod Australia’s profit relative to its shareholders’ equity. For example, if the company invests A$1 in the form of equity, it will generate A$0 in earnings from this. Investors seeking to maximise their return in the Packaged Foods and Meats 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.

ROE is measured against cost of equity in order to determine the efficiency of Murray Cod Australia’s equity capital deployed. Its cost of equity is 8.55%. Since Murray Cod Australia’s return does not cover its cost, with a difference of -8.36%, this means its current use of equity is not efficient and not sustainable. Very simply, Murray Cod Australia pays more 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:

The first component is profit margin, which measures how much of sales is retained after the company pays for all its expenses. Asset turnover reveals how much revenue can be generated from Murray Cod Australia’s asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. 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 Murray Cod Australia’s debt-to-equity ratio to examine sustainability of its returns. The ratio currently stands at a sensible 2.07%, meaning Murray Cod Australia has not taken on excessive debt to drive its returns. The company is able to produce profit growth without a huge debt burden and still has headroom to grow returns to industry average.

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. Murray Cod Australia’s below-industry ROE is disappointing, furthermore, its returns were not even high 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 Murray Cod Australia, I've put together three essential factors 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. Future Earnings: How does Murray Cod Australia's growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
• 3. Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Murray Cod Australia? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!

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Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.