I am writing today to help inform people who are new to the stock market and want to begin learning the link between Hurtimex SA (WSE:HRT)’s return fundamentals and stock market performance.
Hurtimex SA (WSE:HRT) outperformed the apparel, accessories and luxury goods industry on the basis of its ROE – producing a higher 44.73% relative to the peer average of 16.87% over the past 12 months. Though, the impressiveness of HRT’s ROE is contingent on whether this industry-beating level can be sustained. A measure of sustainable returns is HRT’s financial leverage. If HRT borrows debt to invest in its business, its profits will be higher. But ROE does not capture any debt, so we only see high profits and low equity, which is great on the surface. But today let’s take a deeper dive below this surface. See our latest analysis for Hurtimex
Breaking down Return on Equity
Return on Equity (ROE) is a measure of Hurtimex’s profit relative to its shareholders’ equity. An ROE of 44.73% implies PLN0.45 returned on every PLN1 invested, so the higher the return, the better. Investors seeking to maximise their return in the Apparel, Accessories and Luxury Goods 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 Hurtimex 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
Returns are usually compared to costs to measure the efficiency of capital. Hurtimex’s cost of equity is 8.67%. This means Hurtimex returns enough to cover its own cost of equity, with a buffer of 36.06%. This sustainable practice implies that the company pays less 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:
ROE = profit margin × asset turnover × financial leverage
ROE = (annual net profit ÷ sales) × (sales ÷ assets) × (assets ÷ shareholders’ equity)
ROE = annual net profit ÷ shareholders’ equity
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 Hurtimex can make from its 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 Hurtimex’s debt-to-equity ratio to examine sustainability of its returns. The most recent ratio is 230.28%, which is relatively high, indicating Hurtimex’s above-average ROE is generated by its high leverage and its ability to grow profit hinges on a sizeable 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. Hurtimex exhibits a strong ROE against its peers, as well as sufficient returns to cover its cost of equity. Its high debt level means its strong ROE may be driven by debt funding which raises concerns over the sustainability of Hurtimex’s returns. Although ROE can be a useful metric, it is only a small part of diligent research.
For Hurtimex, there are three relevant aspects you should look at:
- 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 Hurtimex’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 Hurtimex? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!