The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and looking to gauge the potential return on investment in West Wits Mining Limited (ASX:WWI).
West Wits Mining Limited (ASX:WWI) generated a below-average return on equity of 2.44% in the past 12 months, while its industry returned 11.89%. WWI’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 WWI’s performance. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of WWI’s returns. Let me show you what I mean by this. View out our latest analysis for West Wits Mining
What you must know about ROE
Return on Equity (ROE) is a measure of West Wits Mining’s profit relative to its shareholders’ equity. An ROE of 2.44% implies A$0.024 returned on every A$1 invested, so the higher the return, the better. Investors seeking to maximise their return in the Gold industry may want to choose 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
ROE is measured against cost of equity in order to determine the efficiency of West Wits Mining’s equity capital deployed. Its cost of equity is 9.74%. This means West Wits Mining’s returns actually do not cover its own cost of equity, with a discrepancy of -7.30%. This isn’t sustainable as it implies, very simply, that the company pays more for its capital than what it generates in return. ROE can be dissected into three distinct 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
Essentially, profit margin shows how much money the company makes after paying for all its expenses. The other component, asset turnover, illustrates how much revenue West Wits Mining can make from its asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. We can assess whether West Wits Mining is fuelling ROE by excessively raising debt. Ideally, West Wits Mining should have a balanced capital structure, which we can check by looking at the historic debt-to-equity ratio of the company. Currently, West Wits Mining has no debt which means its returns are driven purely by equity capital. This could explain why West Wits Mining’s’ ROE is lower than its industry peers, most of which may have some degree of debt in its business.
Next Steps:
ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. West Wits Mining’s below-industry ROE is disappointing, furthermore, its returns were not even high enough to cover its own cost of equity. Although, its appropriate level of leverage means investors can be more confident in the sustainability of West Wits Mining’s return with a possible increase should the company decide to increase its debt levels. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.
For West Wits Mining, there are three important aspects 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.
- Management:Have insiders been ramping up their shares to take advantage of the market’s sentiment for West Wits Mining’s future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
- Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of West Wits Mining? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!