I am writing today to help inform people who are new to the stock market and looking to gauge the potential return on investment in Tahoe Resources Inc (TSE:THO).
Tahoe Resources Inc (TSE:THO) delivered a less impressive 0.009% ROE over the past year, compared to the 11.25% return generated by its industry. Though THO’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 THO’s below-average returns. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of THO’s returns. Let me show you what I mean by this. See our latest analysis for Tahoe Resources
Peeling the layers of ROE – trisecting a company’s profitability
Return on Equity (ROE) is a measure of Tahoe Resources’s profit relative to its shareholders’ equity. It essentially shows how much the company can generate in earnings given the amount of equity it has raised. Investors that are diversifying their portfolio based on industry may want to maximise their return in the Gold sector by choosing 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 Tahoe 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
Returns are usually compared to costs to measure the efficiency of capital. Tahoe Resources’s cost of equity is 17.22%. This means Tahoe Resources’s returns actually do not cover its own cost of equity, with a discrepancy of -17.21%. 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:
ROE = profit margin × asset turnover × financial leverage
ROE = (annual net profit ÷ sales) × (sales ÷ assets) × (assets ÷ shareholders’ equity)
ROE = annual net profit ÷ shareholders’ equity
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 reveals how much revenue can be generated from Tahoe Resources’s 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 determine if Tahoe 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 Tahoe Resources’s debt-to-equity ratio. Currently Tahoe Resources has virtually no debt, which means its returns are predominantly driven by equity capital. This could explain why Tahoe Resources’s’ ROE is lower than its industry peers, most of which may have some degree of debt in its business.
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. Tahoe Resources exhibits a weak ROE against its peers, as well as insufficient levels to cover its own cost of equity this year. 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 Tahoe Resources, I’ve compiled three key 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 Tahoe 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 Tahoe 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!