With an ROE of 30.06%, Pantoro Limited (ASX:PNR) outpaced its own industry which delivered a less exciting 11.24% over the past year. But what is more interesting is whether PNR can sustain this above-average ratio. This can be measured by looking at the company’s financial leverage. With more debt, PNR 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. Check out our latest analysis for Pantoro
What you must know about ROE
Return on Equity (ROE) is a measure of Pantoro’s profit relative to its shareholders’ equity. For example, if the company invests A$1 in the form of equity, it will generate A$0.3 in earnings from this. Investors that are diversifying their portfolio based on industry may want to maximise their return in the Diversified Metals and Mining sector by choosing the highest returning stock. However, this can be deceiving as each company has varying costs of equity and debt levels, which could exaggeratedly push up ROE at the same time as accumulating high interest expense.
Return on Equity = Net Profit ÷ Shareholders Equity
Returns are usually compared to costs to measure the efficiency of capital. Pantoro’s cost of equity is 9.51%. Given a positive discrepancy of 20.55% between return and cost, this indicates that Pantoro pays less for its capital than what it generates in return, which is a sign of capital efficiency. 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. Asset turnover reveals how much revenue can be generated from Pantoro’s asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. We can assess whether Pantoro is fuelling ROE by excessively raising debt. Ideally, Pantoro should have a balanced capital structure, which we can check by looking at the historic debt-to-equity ratio of the company. Currently, Pantoro has no debt which means its returns are driven purely by equity capital. Therefore, the level of financial leverage has no impact on ROE, and the ratio is a representative measure of the efficiency of all its capital employed firm-wide.
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. Pantoro’s ROE is impressive relative to the industry average and also covers its cost of equity. ROE is not likely to be inflated by excessive debt funding, giving shareholders more conviction in the sustainability of high returns. Although ROE can be a useful metric, it is only a small part of diligent research.
For Pantoro, there are three relevant aspects you should look at:
- 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. Valuation: What is Pantoro 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 Pantoro is currently mispriced by the market.
- 3. Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Pantoro? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!