I am writing today to help inform people who are new to the stock market and want to better understand how you can grow your money by investing in Distribuidora Internacional de Alimentación SA (BME:DIA).
With an ROE of 40.18%, Distribuidora Internacional de Alimentación SA (BME:DIA) outpaced its own industry which delivered a less exciting 11.67% over the past year. Though, the impressiveness of DIA’s ROE is contingent on whether this industry-beating level can be sustained. This can be measured by looking at the company’s financial leverage. With more debt, DIA can invest even more and earn more money, thus pushing up its returns. However, ROE only measures returns against equity, not debt. This can be distorted, so let’s take a look at it further. Check out our latest analysis for Distribuidora Internacional de Alimentación
Breaking down ROE — the mother of all ratios
Return on Equity (ROE) weighs Distribuidora Internacional de Alimentación’s profit against the level of its shareholders’ equity. For example, if the company invests €1 in the form of equity, it will generate €0.40 in earnings from this. Investors seeking to maximise their return in the Hypermarkets and Super Centers industry may want to choose 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 Distribuidora Internacional de Alimentación 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 Distribuidora Internacional de Alimentación’s equity capital deployed. Its cost of equity is 8.48%. Given a positive discrepancy of 31.70% between return and cost, this indicates that Distribuidora Internacional de Alimentación pays less for its capital than what it generates in return, which is a sign of capital efficiency. 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. The other component, asset turnover, illustrates how much revenue Distribuidora Internacional de Alimentación can make from its asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. 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 Distribuidora Internacional de Alimentación’s debt-to-equity ratio to examine sustainability of its returns. The ratio currently stands is significantly high, above 2.5 times, meaning Distribuidora Internacional de Alimentación has taken on a disproportionately large level of debt which is driving the high return. The company’s ability to produce profit growth hinges on its large debt burden.
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. Distribuidora Internacional de Alimentación exhibits a strong ROE against its peers, as well as sufficient returns to cover its cost of equity. With debt capital in excess of equity, ROE may be inflated by the use of debt funding, raising questions over the sustainability of the company’s returns. Although ROE can be a useful metric, it is only a small part of diligent research.
For Distribuidora Internacional de Alimentación, I’ve compiled three important factors 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 Distribuidora Internacional de Alimentación 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 Distribuidora Internacional de Alimentación is currently mispriced by the market.
- Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Distribuidora Internacional de Alimentación? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!