Why Ansaldo STS SpA (BIT:STS) Delivered An Inferior ROE Compared To The Industry

I am writing today to help inform people who are new to the stock market and want to begin learning the link between Ansaldo STS SpA (BIT:STS)’s return fundamentals and stock market performance.

Ansaldo STS SpA (BIT:STS) delivered an ROE of 9.22% over the past 12 months, which is relatively in-line with its industry average of 11.20% during the same period. But what is more interesting is whether STS can sustain or improve on this level of return. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of STS’s returns. Let me show you what I mean by this. View out our latest analysis for Ansaldo STS

What you must know about ROE

Return on Equity (ROE) weighs Ansaldo STS’s profit against the level of its shareholders’ equity. An ROE of 9.22% implies €0.092 returned on every €1 invested, so the higher the return, the better. Investors that are diversifying their portfolio based on industry may want to maximise their return in the Highways and Railtracks sector by choosing 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.

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 Ansaldo STS, which is 8.36%. While Ansaldo STS’s peers may have higher ROE, it may also incur higher cost of equity. An undesirable and unsustainable practice would be if returns exceeded cost. However, this is not the case for Ansaldo STS which is encouraging. ROE can be split up into three useful 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

BIT:STS Last Perf July 9th 18
BIT:STS Last Perf July 9th 18

Essentially, profit margin shows how much money the company makes after paying for all its expenses. Asset turnover shows how much revenue Ansaldo STS can generate with its current 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 Ansaldo STS’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 Ansaldo STS’s debt-to-equity ratio. Currently Ansaldo STS has virtually no debt, which means its returns are predominantly driven by equity capital. This could explain why Ansaldo STS’s’ ROE is lower than its industry peers, most of which may have some degree of debt in its business.

BIT:STS Historical Debt July 9th 18
BIT:STS Historical Debt July 9th 18

Next Steps:

ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. Although Ansaldo STS’s ROE is underwhelming relative to the industry average, its returns are high enough to cover the cost of equity. Also, 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 Ansaldo STS, there are three relevant aspects you should look at:

  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 Ansaldo STS 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 Ansaldo STS is currently mispriced by the market.
  3. Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Ansaldo STS? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!