Boruta-Zachem SA.’s (WSE:BRU) most recent return on equity was a substandard 3.25% relative to its industry performance of 8.13% over the past year. An investor may attribute an inferior ROE to a relatively inefficient performance, and whilst this can often be the case, knowing the nuts and bolts of the ROE calculation may change that perspective and give you a deeper insight into BRU’s past performance. I will take you through how metrics such as financial leverage impact ROE which may affect the overall sustainability of BRU’s returns. Check out our latest analysis for Boruta-Zachem
Breaking down ROE — the mother of all ratios
Return on Equity (ROE) weighs Boruta-Zachem’s profit against the level of its shareholders’ equity. It essentially shows how much the company can generate in earnings given the amount of equity it has raised. Investors that are diversifying their portfolio based on industry may want to maximise their return in the Specialty Chemicals sector by choosing 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 Boruta-Zachem 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. Boruta-Zachem’s cost of equity is 8.35%. Since Boruta-Zachem’s return does not cover its cost, with a difference of -5.10%, this means its current use of equity is not efficient and not sustainable. Very simply, Boruta-Zachem pays more for its capital than what it generates in return. ROE can be split up into three useful 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 Boruta-Zachem 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. We can determine if Boruta-Zachem’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 Boruta-Zachem’s debt-to-equity ratio. Currently the ratio stands at 3.28%, which is very low. This means Boruta-Zachem has not taken on leverage, which could explain its below-average ROE. Boruta-Zachem still has headroom to take on more leverage in order to grow its returns.
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. Boruta-Zachem 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 Boruta-Zachem’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 Boruta-Zachem, there are three key factors you should further examine 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.
- 1. Financial Health: Does it have a healthy balance sheet? Take a look at this free balance sheet analysis with six simple checks on key factors like leverage and risk.
- 2. Future Earnings: How does Boruta-Zachem’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 Simply Wall St’s free analyst growth expectation chart.
- 3. Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Boruta-Zachem? Explore this interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!