intu properties plc (LSE:INTU) generated a below-average return on equity of 3.96% in the past 12 months, while its industry returned 10.56%. Though INTU’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 INTU’s below-average returns. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of INTU’s returns. Let me show you what I mean by this. View our latest analysis for intu properties
What you must know about ROE
Return on Equity (ROE) weighs intu properties’s profit against the level of its shareholders’ equity. For example, if the company invests £1 in the form of equity, it will generate £0.04 in earnings from this. Investors that are diversifying their portfolio based on industry may want to maximise their return in the Retail REITs sector by choosing the highest returning stock. However, this can be deceiving as each company has varying costs of equity and debt levels, which could exaggeratedly push up ROE at the same time as accumulating high interest expense.
Return on Equity = Net Profit ÷ Shareholders Equity
ROE is measured against cost of equity in order to determine the efficiency of intu properties’s equity capital deployed. Its cost of equity is 12.40%. This means intu properties’s returns actually do not cover its own cost of equity, with a discrepancy of -8.44%. 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 dissected into three distinct 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. Asset turnover shows how much revenue intu properties can generate with its current 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 intu properties’s debt-to-equity ratio to examine sustainability of its returns. The most recent ratio is 104.22%, which is relatively proportionate and indicates intu properties has not taken on extreme leverage. Thus, we can conclude its current ROE is generated from its capacity to increase profit without a massive debt burden.
While ROE is a relatively simple calculation, it can be broken down into different ratios, each telling a different story about the strengths and weaknesses of a company. intu properties’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. Although ROE can be a useful metric, it is only a small part of diligent research.
For intu properties, I’ve compiled three essential aspects 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.
- Valuation: What is intu properties 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 intu properties is currently mispriced by the market.
- Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of intu properties? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!