This analysis is intended to introduce important early concepts to people who are starting to invest and looking to gauge the potential return on investment in Renforth Resources Inc (CNSX:RFR).
Renforth Resources Inc (CNSX:RFR) delivered a less impressive 1.46% ROE over the past year, compared to the 11.07% return generated by its industry. RFR’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 RFR’s performance. I will take you through how metrics such as financial leverage impact ROE which may affect the overall sustainability of RFR’s returns. See our latest analysis for Renforth Resources
Peeling the layers of ROE – trisecting a company’s profitability
Return on Equity (ROE) weighs Renforth Resources’s profit against the level of its shareholders’ equity. An ROE of 1.46% implies CA$0.015 returned on every CA$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 misleading as each firm has different costs of equity and debt levels i.e. the more debt Renforth Resources has, the higher ROE is pumped up in the short term, at the expense of long term interest payment burden.
Return on Equity = Net Profit ÷ Shareholders Equity
ROE is measured against cost of equity in order to determine the efficiency of Renforth Resources’s equity capital deployed. Its cost of equity is 17.14%. Since Renforth Resources’s return does not cover its cost, with a difference of -15.68%, this means its current use of equity is not efficient and not sustainable. Very simply, Renforth Resources 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:
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. Asset turnover shows how much revenue Renforth Resources 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. We can determine if Renforth Resources’s ROE is inflated by borrowing high levels of debt. Generally, a balanced capital structure means its returns will be sustainable over the long run. We can examine this by looking at Renforth Resources’s debt-to-equity ratio. Currently, Renforth Resources has no debt which means its returns are driven purely by equity capital. This could explain why Renforth Resources’s’ ROE is lower than its industry peers, most of which may have some degree of debt in its business.
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. Renforth Resources’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. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.
For Renforth Resources, I’ve put together three pertinent 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.
- Future Earnings: How does Renforth Resources’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.
- Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Renforth Resources? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!