Why Daios Plastics SA. (ATH:DAIOS) May Not Be As Efficient As Its Industry

Daios Plastics SA. (ATSE:DAIOS) performed in line with its commodity chemicals industry on the basis of its ROE – producing a return of12.36% relative to the peer average of 12.90% over the past 12 months. But what is more interesting is whether DAIOS 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 DAIOS's returns. View our latest analysis for Daios Plastics

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. It essentially shows how much the company can generate in earnings given the amount of equity it has raised. If investors diversify their portfolio by industry, they may want to maximise their return in the Commodity Chemicals sector by investing in the highest returning stock. But this can be misleading as each company has different costs of equity and also varying debt levels, which could artificially push up ROE whilst accumulating high interest expense.

ROE is assessed against cost of equity, which is measured using the Capital Asset Pricing Model (CAPM) – but let’s not dive into the details of that today. For now, let’s just look at the cost of equity number for Daios Plastics, which is 15.77%. This means Daios Plastics’s returns actually do not cover its own cost of equity, with a discrepancy of -3.41%. 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:

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 Daios Plastics can make from its asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. We can determine if Daios Plastics’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 Daios Plastics’s debt-to-equity ratio. Currently the ratio stands at more than 2.5 times, which is very high. This is not a good sign given Daios Plastics's below-average ROE is already being driven by its significant debt levels and its ability to grow profit hinges on a significant debt burden.

Next Steps:

ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. Daios Plastics’s below-industry ROE is disappointing, furthermore, its returns were not even high enough to cover its own cost of equity. Although, its appropriate level of leverage means investors can be more confident in the sustainability of Daios Plastics’s return with a possible increase should the company decide to increase its debt levels. Although ROE can be a useful metric, it is only a small part of diligent research.

For Daios Plastics, there are three important aspects 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 Daios Plastics 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 Daios Plastics is currently mispriced by the market.
• 3. Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Daios Plastics? 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.