What You Must Know About Ormester Vagyonvédelmi Nyrt’s (BUSE:ORMESTER) Return on Equity

Ormester Vagyonvédelmi Nyrt’s (BUSE:ORMESTER) most recent return on equity was a substandard 2.59% relative to its industry performance of 10.64% over the past year. ORMESTER’s results could indicate a relatively inefficient operation to its peers, and while this may be the case, it is important to understand what ROE is made up of and how it should be interpreted. Knowing these components could change your view on ORMESTER’s performance. Today I will look at how components such as financial leverage can influence ROE which may impact the sustainability of ORMESTER’s returns. See our latest analysis for Ormester Vagyonvédelmi Nyrt

Breaking down Return on Equity

Return on Equity (ROE) is a measure of Ormester Vagyonvédelmi Nyrt’s profit relative to its shareholders’ equity. For example, if the company invests HUF1 in the form of equity, it will generate HUF0.03 in earnings from this. Investors that are diversifying their portfolio based on industry may want to maximise their return in the Security and Alarm Services 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

Returns are usually compared to costs to measure the efficiency of capital. Ormester Vagyonvédelmi Nyrt’s cost of equity is 8.35%. Given a discrepancy of -5.76% between return and cost, this indicated that Ormester Vagyonvédelmi Nyrt may be paying more for its capital than what it’s generating 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

BUSE:ORMESTER Last Perf Mar 9th 18
BUSE:ORMESTER Last Perf Mar 9th 18

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 Ormester Vagyonvédelmi Nyrt can make from its 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. 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 most recent ratio is 41.18%, which is sensible and indicates Ormester Vagyonvédelmi Nyrt has not taken on too much leverage. Thus, we can conclude its below-average ROE may be a result of low debt, and Ormester Vagyonvédelmi Nyrt still has room to increase leverage and grow future returns.

BUSE:ORMESTER Historical Debt Mar 9th 18
BUSE:ORMESTER Historical Debt Mar 9th 18

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. Although ROE can be a useful metric, it is only a small part of diligent research.

For Ormester Vagyonvédelmi Nyrt, there are three fundamental factors you should look at below. Just a heads up – to access some parts of the Simply Wall St research tool you might be asked to create a free account, but it takes just one click and the information they provide is definitely worth it in my opinion.