This article is intended for those of you who are at the beginning of your investing journey and want a simplistic look at the return on Abano Healthcare Group Limited (NZSE:ABA) stock.
Abano Healthcare Group Limited (NZSE:ABA) delivered a less impressive 7.23% ROE over the past year, compared to the 11.82% return generated by its industry. Though ABA’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 ABA’s below-average returns. I will take you through how metrics such as financial leverage impact ROE which may affect the overall sustainability of ABA’s returns. See our latest analysis for Abano Healthcare Group
What you must know about ROE
Return on Equity (ROE) is a measure of Abano Healthcare Group’s profit relative to its shareholders’ equity. For example, if the company invests NZ$1 in the form of equity, it will generate NZ$0.072 in earnings from this. Investors that are diversifying their portfolio based on industry may want to maximise their return in the Healthcare Services 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
Returns are usually compared to costs to measure the efficiency of capital. Abano Healthcare Group’s cost of equity is 9.01%. Given a discrepancy of -1.78% between return and cost, this indicated that Abano Healthcare Group may be paying more for its capital than what it’s generating in return. ROE can be broken down into three different 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. The other component, asset turnover, illustrates how much revenue Abano Healthcare Group can make from its 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. 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 Abano Healthcare Group’s debt-to-equity ratio to examine sustainability of its returns. The most recent ratio is 68.90%, which is sensible and indicates Abano Healthcare Group has not taken on too much leverage. Thus, we can conclude its current ROE is generated from its capacity to increase profit without a large debt burden.
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. Abano Healthcare Group’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 Abano Healthcare Group’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 Abano Healthcare Group, there are three pertinent aspects 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 Abano Healthcare Group’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 Abano Healthcare Group? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!