I am writing today to help inform people who are new to the stock market and want to begin learning the link between Cortex Business Solutions Inc (CVE:CBX)’s return fundamentals and stock market performance.
Cortex Business Solutions Inc (CVE:CBX) outperformed the internet software and services industry on the basis of its ROE – producing a higher 14.70% relative to the peer average of 11.54% over the past 12 months. But what is more interesting is whether CBX can sustain this above-average ratio. A measure of sustainable returns is CBX’s financial leverage. If CBX 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 Cortex Business Solutions
Peeling the layers of ROE – trisecting a company’s profitability
Return on Equity (ROE) weighs Cortex Business Solutions’s profit against the level of its shareholders’ equity. For example, if the company invests CA$1 in the form of equity, it will generate CA$0.15 in earnings from this. If investors diversify their portfolio by industry, they may want to maximise their return in the Internet Software and Services sector by investing in 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 Cortex Business Solutions 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 Cortex Business Solutions’s equity capital deployed. Its cost of equity is 11.94%. Given a positive discrepancy of 2.75% between return and cost, this indicates that Cortex Business Solutions pays less for its capital than what it generates in return, which is a sign of capital efficiency. 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 shows how much revenue Cortex Business Solutions 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 assess whether Cortex Business Solutions is fuelling ROE by excessively raising debt. Ideally, Cortex Business Solutions should have a balanced capital structure, which we can check by looking at the historic debt-to-equity ratio of the company. Currently Cortex Business Solutions has virtually no debt, which means its returns are predominantly driven by equity capital. Therefore, the level of financial leverage has no impact on ROE, and the ratio is a representative measure of the efficiency of all its capital employed firm-wide.
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. Cortex Business Solutions’s above-industry ROE is encouraging, and is also in excess of its 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. Although ROE can be a useful metric, it is only a small part of diligent research.
For Cortex Business Solutions, I’ve put together three relevant aspects you should look at:
- 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.
- Valuation: What is Cortex Business Solutions 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 Cortex Business Solutions is currently mispriced by the market.
- Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Cortex Business Solutions? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!