Why Phoenix Global Resources plc (LON:PGR) Delivered An Inferior ROE Compared To The Industry

Phoenix Global Resources plc’s (AIM:PGR) most recent return on equity was a substandard 2.61% relative to its industry performance of 5.74% over the past year. PGR's results could indicate a relatively inefficient operation to its peers, and while this may be the case, it is important to understand what ROE is made up of and how it should be interpreted. Knowing these components could change your view on PGR’s performance. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of PGR's returns. Let me show you what I mean by this. View our latest analysis for Phoenix Global Resources

Peeling the layers of ROE – trisecting a company’s profitability

Return on Equity (ROE) is a measure of Phoenix Global Resources’s profit relative to its shareholders’ equity. An ROE of 2.61% implies £0.03 returned on every £1 invested, so the higher the return, the better. Investors that are diversifying their portfolio based on industry may want to maximise their return in the Oil and Gas Exploration and Production 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 Phoenix Global Resources has, the higher ROE is pumped up in the short term, at the expense of long term interest payment burden.

ROE is measured against cost of equity in order to determine the efficiency of Phoenix Global Resources’s equity capital deployed. Its cost of equity is 8.30%. This means Phoenix Global Resources’s returns actually do not cover its own cost of equity, with a discrepancy of -5.69%. 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:

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 Phoenix Global Resources can make from its 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. We can determine if Phoenix Global Resources’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 Phoenix Global Resources’s debt-to-equity ratio. Currently the ratio stands at 15.55%, which is very low. This means Phoenix Global Resources has not taken on leverage, which could explain its below-average ROE. Phoenix Global Resources still has headroom to take on more leverage in order to grow its returns.

Why is ROE called the mother of all ratios

ROE is a relatively simple calculation, but it can be broken down into different ratios, each telling a different story about the strengths and weaknesses of a company. Phoenix Global Resources’s ROE is underwhelming relative to the industry average, and its returns were also not strong enough to cover its own cost of equity. 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 Phoenix Global Resources, I've compiled three important factors you should look at:

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 Phoenix Global Resources'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 Phoenix Global Resources? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!

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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.