The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want a simplistic look at the return on Bluebird Merchant Ventures Limited (LON:BMV) stock.
With an ROE of 54.36%, Bluebird Merchant Ventures Limited (LON:BMV) outpaced its own industry which delivered a less exciting 10.94% over the past year. However, whether this above-industry ROE is actually impressive depends on if it can be maintained. A measure of sustainable returns is BMV’s financial leverage. If BMV borrows debt to invest in its business, its profits will be higher. But ROE does not capture any debt, so we only see high profits and low equity, which is great on the surface. But today let’s take a deeper dive below this surface. See our latest analysis for Bluebird Merchant Ventures
Breaking down ROE — the mother of all ratios
Return on Equity (ROE) weighs Bluebird Merchant Ventures’s profit against the level of its shareholders’ equity. An ROE of 54.36% implies £0.54 returned on every £1 invested, so the higher the return, the better. If investors diversify their portfolio by industry, they may want to maximise their return in the Gold sector by investing in 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 Bluebird Merchant Ventures 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. Bluebird Merchant Ventures’s cost of equity is 9.55%. Given a positive discrepancy of 44.81% between return and cost, this indicates that Bluebird Merchant Ventures 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:
ROE = profit margin × asset turnover × financial leverage
ROE = (annual net profit ÷ sales) × (sales ÷ assets) × (assets ÷ shareholders’ equity)
ROE = annual net profit ÷ shareholders’ equity
Basically, profit margin measures how much of revenue trickles down into earnings which illustrates how efficient the business is with its cost management. Asset turnover reveals how much revenue can be generated from Bluebird Merchant Ventures’s asset base. Finally, financial leverage will be our main focus today. It shows how much of assets are funded by equity and can show how sustainable the company’s capital structure is. We can determine if Bluebird Merchant Ventures’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 Bluebird Merchant Ventures’s debt-to-equity ratio. The ratio currently stands at a sensible 19.46%, meaning Bluebird Merchant Ventures has not taken on excessive debt to drive its returns. The company is able to produce profit growth without a huge debt burden.
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. Bluebird Merchant Ventures’s above-industry ROE is encouraging, and is also in excess of 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 Bluebird Merchant Ventures, there are three essential factors you should further research:
- 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.
- Future Earnings: How does Bluebird Merchant Ventures’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.
- Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Bluebird Merchant Ventures? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!