With An ROE Of 9.57%, Has Kinross Gold Corporation's (TSE:K) Management Done A Good Job?

With an ROE of 9.57%, Kinross Gold Corporation (TSX:K) returned in-line to its own industry which delivered 7.43% over the past year. However, whether this ROE is actually impressive depends on if it can be maintained. A measure of sustainable returns is K’s financial leverage. If K borrows debt to invest in its business, its profits will be higher. But ROE does not capture any debt, so we only see high profits and low equity, which is great on the surface. But today let’s take a deeper dive below this surface. See our latest analysis for Kinross Gold

Peeling the layers of ROE – trisecting a company’s profitability

Return on Equity (ROE) is a measure of Kinross Gold’s profit relative to its shareholders’ equity. For example, if the company invests CA$1 in the form of equity, it will generate CA$0.1 in earnings from this. 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.

ROE is measured against cost of equity in order to determine the efficiency of Kinross Gold’s equity capital deployed. Its cost of equity is 17.87%. This means Kinross Gold’s returns actually do not cover its own cost of equity, with a discrepancy of -8.30%. 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 broken down into three different 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. Asset turnover shows how much revenue Kinross Gold can generate with its current asset base. And finally, financial leverage is simply how much of assets are funded by equity, which exhibits how sustainable the company’s capital structure is. We can assess whether Kinross Gold is fuelling ROE by excessively raising debt. Ideally, Kinross Gold should have a balanced capital structure, which we can check by looking at the historic debt-to-equity ratio of the company. Currently the ratio stands at 37.51%, which is very low. This means Kinross Gold has not taken on leverage, and its above-average ROE is driven by its ability to grow its profit without a huge debt burden.

Next Steps:

ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. Kinross Gold’s above-industry ROE is noteworthy, but it was not high enough to cover its own cost of equity. Its high ROE is not likely to be driven by high debt. Therefore, investors may have more confidence in the sustainability of this level of returns going forward. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.

For Kinross Gold, I've put together 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 Kinross Gold 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 Kinross Gold is currently mispriced by the market.
• 3. Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Kinross Gold? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!