Will Carindale Property Trust (ASX:CDP) Continue To Underperform Its Industry?

The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to begin learning the link between Carindale Property Trust (ASX:CDP)’s return fundamentals and stock market performance.

Carindale Property Trust (ASX:CDP) delivered a less impressive 5.19% ROE over the past year, compared to the 13.18% return generated by its industry. CDP'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 CDP’s performance. 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

Return on Equity (ROE) is a measure of Carindale Property Trust’s profit relative to its shareholders’ equity. An ROE of 5.19% implies A$0.052 returned on every A$1 invested, so the higher the return, the better. Investors that are diversifying their portfolio based on industry may want to maximise their return in the Retail REITs sector by choosing 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 Carindale Property Trust, which is 8.55%. Given a discrepancy of -3.37% 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:

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

The first component is profit margin, which measures how much of sales is retained after the company pays for all its expenses. Asset turnover shows how much revenue Carindale Property Trust can generate with its current 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. 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 Carindale Property Trust’s debt-to-equity ratio to examine sustainability of its returns. Currently the ratio stands at 39.48%, which is very low. This means Carindale Property Trust has not taken on leverage, which could explain its below-average ROE. Carindale Property Trust still has headroom to take on more leverage in order to grow its returns.

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. 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. 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 Carindale Property Trust, there are three key aspects 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. 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.