Why Carindale Property Trust (ASX:CDP) May Not Be As Efficient As Its Industry

Carindale Property Trust’s (ASX:CDP) most recent return on equity was a substandard 5.19% relative to its industry performance of 13.45% over the past year. Though CDP's recent performance is underwhelming, it is useful to understand what ROE is made up of and how it should be interpreted. Knowing these components can change your views on CDP's below-average returns. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of CDP's returns. Let me show you what I mean by this. See our latest analysis for Carindale Property Trust

Breaking down Return on Equity

Firstly, Return on Equity, or ROE, is simply the percentage of last years’ earning against the book value of shareholders’ equity. For example, if the company invests A$1 in the form of equity, it will generate A$0.05 in earnings from this. If investors diversify their portfolio by industry, they may want to maximise their return in the Retail REITs sector by investing in 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.

Returns are usually compared to costs to measure the efficiency of capital. Carindale Property Trust’s cost of equity is 8.55%. Given a discrepancy of -3.36% between return and cost, this indicated that Carindale Property Trust may be paying more for its capital than what it’s generating 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:

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 Carindale Property Trust can make from its asset base. Finally, financial leverage will be our main focus today. It shows how much of assets are funded by equity and can show how sustainable the company’s capital structure is. We can assess whether Carindale Property Trust is fuelling ROE by excessively raising debt. Ideally, Carindale Property Trust should have a balanced capital structure, which we can check by looking at the historic debt-to-equity ratio of the company. The most recent ratio is 39.48%, which is sensible and indicates Carindale Property Trust has not taken on too much leverage. Thus, we can conclude its below-average ROE may be a result of low debt, and Carindale Property Trust still has room to increase leverage and grow future returns.

Next Steps:

ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. Carindale Property Trust’s ROE is underwhelming relative to the industry average, and its returns were also not strong enough to cover its own cost of equity. Although, its appropriate level of leverage means investors can be more confident in the sustainability of Carindale Property Trust’s return with a possible increase should the company decide to increase its debt levels. Although ROE can be a useful metric, it is only a small part of diligent research.

For Carindale Property Trust, I've put together three relevant aspects you should further examine:

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 Carindale Property Trust 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 Carindale Property Trust is currently mispriced by the market.
3. Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Carindale Property Trust? 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.