How Did NH Hotel Group SA's (BME:NHH) 7.25% ROE Fare Against The Industry?

I am writing today to help inform people who are new to the stock market and looking to gauge the potential return on investment in NH Hotel Group SA (BME:NHH).

NH Hotel Group SA’s (BME:NHH) most recent return on equity was a substandard 7.25% relative to its industry performance of 12.79% over the past year. Though NHH'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 NHH's below-average returns. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of NHH's returns. Let me show you what I mean by this. Check out our latest analysis for NH Hotel Group

What you must know about ROE

Return on Equity (ROE) is a measure of NH Hotel Group’s profit relative to its shareholders’ equity. An ROE of 7.25% implies €0.073 returned on every €1 invested, so the higher the return, the better. Investors seeking to maximise their return in the Hotels, Resorts and Cruise Lines 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 NH Hotel Group 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 NH Hotel Group’s equity capital deployed. Its cost of equity is 10.64%. Since NH Hotel Group’s return does not cover its cost, with a difference of -3.39%, this means its current use of equity is not efficient and not sustainable. Very simply, NH Hotel Group 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:

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

The first component is profit margin, which measures how much of sales is retained after the company pays for all its expenses. The other component, asset turnover, illustrates how much revenue NH Hotel Group can make from its asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. We can determine if NH Hotel Group’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 NH Hotel Group’s debt-to-equity ratio. The ratio currently stands at a sensible 62.19%, meaning NH Hotel Group has not taken on excessive debt to drive its returns. The company is able to produce profit growth without a huge debt burden.

Next Steps:

ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. NH Hotel Group exhibits a weak ROE against its peers, as well as insufficient levels to cover its own cost of equity this year. 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. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.

For NH Hotel Group, I've compiled three pertinent 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. Valuation: What is NH Hotel Group 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 NH Hotel Group is currently mispriced by the market.
3. Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of NH Hotel Group? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com

Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.