Münchener Tierpark Hellabrunn AG (MUN:MTP) generated a below-average return on equity of 2.46% in the past 12 months, while its industry returned 12.24%. An investor may attribute an inferior ROE to a relatively inefficient performance, and whilst this can often be the case, knowing the nuts and bolts of the ROE calculation may change that perspective and give you a deeper insight into MTP’s past performance. Today I will look at how components such as financial leverage can influence ROE which may impact the sustainability of MTP’s returns. View our latest analysis for Münchener Tierpark Hellabrunn
What you must know about ROE
Return on Equity (ROE) is a measure of Münchener Tierpark Hellabrunn’s profit relative to its shareholders’ equity. For example, if the company invests €1 in the form of equity, it will generate €0.02 in earnings from this. Investors that are diversifying their portfolio based on industry may want to maximise their return in the Leisure Facilities sector by choosing 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 assessed against cost of equity, which is measured using the Capital Asset Pricing Model (CAPM) – but let’s not dive into the details of that today. For now, let’s just look at the cost of equity number for Münchener Tierpark Hellabrunn, which is 10.60%. This means Münchener Tierpark Hellabrunn’s returns actually do not cover its own cost of equity, with a discrepancy of -8.14%. 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 split up into three useful 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 Münchener Tierpark Hellabrunn’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. ROE can be inflated by disproportionately high levels of debt. This is also unsustainable due to the high interest cost that the company will also incur. Thus, we should look at Münchener Tierpark Hellabrunn’s debt-to-equity ratio to examine sustainability of its returns. Currently, Münchener Tierpark Hellabrunn has no debt which means its returns are driven purely by equity capital. This could explain why Münchener Tierpark Hellabrunn’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. Münchener Tierpark Hellabrunn exhibits a weak ROE against its peers, as well as insufficient levels to cover its own cost of equity this year. Although, its appropriate level of leverage means investors can be more confident in the sustainability of Münchener Tierpark Hellabrunn’s return with a possible increase should the company decide to increase its debt levels. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.
For Münchener Tierpark Hellabrunn, I’ve compiled three important aspects 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. Future Earnings: How does Münchener Tierpark Hellabrunn’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.
- 3. Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Münchener Tierpark Hellabrunn? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!