This article is intended for those of you who are at the beginning of your investing journey and want to better understand how you can grow your money by investing in Aggregated Micro Power Holdings plc (LON:AMPH).
Aggregated Micro Power Holdings plc (LON:AMPH) delivered an ROE of 6.52% over the past 12 months, which is relatively in-line with its industry average of 6.86% during the same period. But what is more interesting is whether AMPH can sustain or improve on this level of return. I will take you through how metrics such as financial leverage impact ROE which may affect the overall sustainability of AMPH’s returns. Check out our latest analysis for Aggregated Micro Power Holdings
Peeling the layers of ROE – trisecting a company’s profitability
Return on Equity (ROE) weighs Aggregated Micro Power Holdings’s profit against the level of its shareholders’ equity. An ROE of 6.52% implies £0.065 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 Renewable Electricity sector by investing in 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
Returns are usually compared to costs to measure the efficiency of capital. Aggregated Micro Power Holdings’s cost of equity is 8.28%. This means Aggregated Micro Power Holdings’s returns actually do not cover its own cost of equity, with a discrepancy of -1.76%. 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:
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 reveals how much revenue can be generated from Aggregated Micro Power Holdings’s 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 Aggregated Micro Power Holdings’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 Aggregated Micro Power Holdings’s debt-to-equity ratio. The ratio currently stands at a balanced 116.20%, meaning Aggregated Micro Power Holdings has not taken on excessively disproportionate debt to drive its returns. The company is able to produce profit growth without a substantial debt burden.
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. Aggregated Micro Power Holdings 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 Aggregated Micro Power Holdings, there are three relevant aspects you should look at:
- 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 Aggregated Micro Power Holdings’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 Aggregated Micro Power Holdings? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!