Impexmetal SA. (WSE:IPX) generated a below-average return on equity of 7.70% in the past 12 months, while its industry returned 11.78%. IPX’s results could indicate a relatively inefficient operation to its peers, and while this may be the case, it is important to understand what ROE is made up of and how it should be interpreted. Knowing these components could change your view on IPX’s performance. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of IPX’s returns. Let me show you what I mean by this. See our latest analysis for Impexmetal
Breaking down ROE — the mother of all ratios
Return on Equity (ROE) weighs Impexmetal’s profit against the level of its shareholders’ equity. For example, if the company invests PLN1 in the form of equity, it will generate PLN0.08 in earnings from this. If investors diversify their portfolio by industry, they may want to maximise their return in the Diversified Metals and Mining sector by investing in 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 Impexmetal, which is 13.12%. This means Impexmetal’s returns actually do not cover its own cost of equity, with a discrepancy of -5.42%. This isn’t sustainable as it implies, very simply, that the company 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
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 reveals how much revenue can be generated from Impexmetal’s 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. 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 Impexmetal’s debt-to-equity ratio to examine sustainability of its returns. Currently the ratio stands at 28.15%, which is very low. This means Impexmetal has not taken on leverage, which could explain its below-average ROE. Impexmetal still has headroom to take on more leverage in order to grow its returns.
ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. Impexmetal’s ROE is underwhelming relative to the industry average, and its returns were also not strong enough to cover its own cost of equity. However, 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. Although ROE can be a useful metric, it is only a small part of diligent research.
For Impexmetal, there are three key factors you should further examine:
- 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. Future Earnings: How does Impexmetal’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.
- 3. Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Impexmetal? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!