Will Tahoe Resources Inc (TSE:THO) Continue To Underperform Its Industry?

Tahoe Resources Inc’s (TSX:THO) most recent return on equity was a substandard 3.83% relative to its industry performance of 7.39% over the past year. 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. I will take you through how metrics such as financial leverage impact ROE which may affect the overall sustainability of THO’s returns. See our latest analysis for Tahoe Resources

Breaking down ROE — the mother of all ratios

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 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.

Return on Equity = Net Profit ÷ Shareholders Equity

ROE is measured against cost of equity in order to determine the efficiency of Tahoe Resources’s equity capital deployed. Its cost of equity is 17.87%. Given a discrepancy of -14.04% between return and cost, this indicated that Tahoe Resources may be paying more for its capital than what it’s generating 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:

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

TSX:THO Last Perf Feb 6th 18
TSX:THO Last Perf Feb 6th 18

Essentially, profit margin shows how much money the company makes after paying for all its expenses. 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 the ratio stands at 1.70%, which is very low. This means Tahoe Resources has not taken on leverage, which could explain its below-average ROE. Tahoe Resources still has headroom to take on more leverage in order to grow its returns.

TSX:THO Historical Debt Feb 6th 18
TSX:THO Historical Debt Feb 6th 18

Next Steps:

ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. Tahoe 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. Although ROE can be a useful metric, it is only a small part of diligent research.

For Tahoe Resources, I’ve put together three important factors you should further research: