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:
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 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.
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:
- 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 Tahoe Resources 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 Tahoe Resources is currently mispriced by the market.
- 3. 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!