Ormester Vagyonvédelmi Nyrt’s (BUSE:ORMESTER) most recent return on equity was a substandard 2.59% relative to its industry performance of 10.84% over the past year. Though ORMESTER’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 ORMESTER’s below-average returns. I will take you through how metrics such as financial leverage impact ROE which may affect the overall sustainability of ORMESTER’s returns. See our latest analysis for Ormester Vagyonvédelmi Nyrt
What you must know about ROE
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 Security and Alarm Services 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
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%. Given a discrepancy of -5.96% 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:
ROE = profit margin × asset turnover × financial leverage
ROE = (annual net profit ÷ sales) × (sales ÷ assets) × (assets ÷ shareholders’ equity)
ROE = annual net profit ÷ shareholders’ equity
Basically, profit margin measures how much of revenue trickles down into earnings which illustrates how efficient the business is with its cost management. Asset turnover shows how much revenue Ormester Vagyonvédelmi Nyrt can generate with its current asset base. Finally, financial leverage will be our main focus today. It shows how much of assets are funded by equity and can show how sustainable the company’s capital structure is. We can assess whether Ormester Vagyonvédelmi Nyrt is fuelling ROE by excessively raising debt. Ideally, Ormester Vagyonvédelmi Nyrt should have a balanced capital structure, which we can check by looking at the historic debt-to-equity ratio of the company. Currently the ratio stands at 41.18%, which is very low. This means Ormester Vagyonvédelmi Nyrt has not taken on leverage, which could explain its below-average ROE. Ormester Vagyonvédelmi Nyrt still has headroom to take on more leverage in order to grow its returns.
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. Ormester Vagyonvédelmi Nyrt exhibits a weak ROE against its peers, as well as insufficient levels to cover its own cost of equity this year. 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 compiled three key factors 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.
- 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!