What is Behind Whitbread PLC’s (LON:WTB) Superior ROE?

This analysis is intended to introduce important early concepts to people who are starting to invest and want to better understand how you can grow your money by investing in Whitbread PLC (LON:WTB).

With an ROE of 15.57%, Whitbread PLC (LON:WTB) outpaced its own industry which delivered a less exciting 10.39% over the past year. But what is more interesting is whether WTB can sustain this above-average ratio. Sustainability can be gauged by a company’s financial leverage – the more debt it has, the higher ROE is pumped up in the short term, at the expense of long term interest payment burden. Let me show you what I mean by this. View out our latest analysis for Whitbread

Breaking down Return on Equity

Firstly, Return on Equity, or ROE, is simply the percentage of last years’ earning against the book value of shareholders’ equity. For example, if the company invests £1 in the form of equity, it will generate £0.16 in earnings from this. Investors that are diversifying their portfolio based on industry may want to maximise their return in the Restaurants sector by choosing 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 Whitbread 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

Returns are usually compared to costs to measure the efficiency of capital. Whitbread’s cost of equity is 8.28%. Given a positive discrepancy of 7.29% between return and cost, this indicates that Whitbread pays less for its capital than what it generates in return, which is a sign of capital efficiency. ROE can be broken down into three different 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

LSE:WTB Last Perf July 5th 18
LSE:WTB Last Perf July 5th 18

Essentially, profit margin shows how much money the company makes after paying for all its expenses. Asset turnover shows how much revenue Whitbread can generate with its current asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. We can determine if Whitbread’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 Whitbread’s debt-to-equity ratio. Currently the ratio stands at 33.23%, which is very low. This means Whitbread has not taken on leverage, and its above-average ROE is driven by its ability to grow its profit without a huge debt burden.

LSE:WTB Historical Debt July 5th 18
LSE:WTB Historical Debt July 5th 18

Next Steps:

ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. Whitbread’s ROE is impressive relative to the industry average and also covers its cost of equity. ROE is not likely to be inflated by excessive debt funding, giving shareholders more conviction in the sustainability of high returns. Although ROE can be a useful metric, it is only a small part of diligent research.

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