I am writing today to help inform people who are new to the stock market and want a simplistic look at the return on Ormester Vagyonvédelmi Nyrt (BUSE:ORMESTER) stock.
Ormester Vagyonvédelmi Nyrt (BUSE:ORMESTER) delivered a less impressive 2.59% ROE over the past year, compared to the 11.60% return generated by its industry. An investor may attribute an inferior ROE to a relatively inefficient performance, and whilst this can often be the case, knowing the nuts and bolts of the ROE calculation may change that perspective and give you a deeper insight into ORMESTER’s past performance. Today I will look at how components such as financial leverage can influence ROE which may impact the sustainability of ORMESTER’s returns. Check out our latest analysis for Ormester Vagyonvédelmi Nyrt
Peeling the layers of ROE – trisecting a company’s profitability
Return on Equity (ROE) is a measure of Ormester Vagyonvédelmi Nyrt’s profit relative to its shareholders’ equity. It essentially shows how much the company can generate in earnings given the amount of equity it has raised. Investors seeking to maximise their return in the Security and Alarm Services industry may want to choose 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 Ormester Vagyonvédelmi Nyrt 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
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 Ormester Vagyonvédelmi Nyrt, which is 8.55%. Since Ormester Vagyonvédelmi Nyrt’s return does not cover its cost, with a difference of -5.96%, this means its current use of equity is not efficient and not sustainable. Very simply, Ormester Vagyonvédelmi Nyrt 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:
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
The first component is profit margin, which measures how much of sales is retained after the company pays for all its expenses. Asset turnover shows how much revenue Ormester Vagyonvédelmi Nyrt 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 Ormester Vagyonvédelmi Nyrt’s debt-to-equity ratio to examine sustainability of its returns. The ratio currently stands at a sensible 41.18%, meaning Ormester Vagyonvédelmi Nyrt has not taken on excessive debt to drive its returns. The company is able to produce profit growth without a huge debt burden.
Next Steps:
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. Ormester Vagyonvédelmi Nyrt’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 Ormester Vagyonvédelmi Nyrt’s return with a possible increase should the company decide to increase its debt levels. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.
For Ormester Vagyonvédelmi Nyrt, I’ve put together three relevant aspects you should further examine:
- 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 Ormester Vagyonvédelmi Nyrt’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 Ormester Vagyonvédelmi Nyrt? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!