Public Stock Company VSMPO-AVISMA Corporation’s (MISX:VSMO) most recent return on equity was a substandard 13.91% relative to its industry performance of 24.78% over the past year. VSMO’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 VSMO’s performance. Today I will look at how components such as financial leverage can influence ROE which may impact the sustainability of VSMO’s returns. Check out our latest analysis for Public Stock Company VSMPO-AVISMA
Peeling the layers of ROE – trisecting a company’s profitability
Return on Equity (ROE) weighs Public Stock Company VSMPO-AVISMA’s profit against the level of its shareholders’ equity. For example, if the company invests RUB1 in the form of equity, it will generate RUB0.14 in earnings from this. Investors that are diversifying their portfolio based on industry may want to maximise their return in the Diversified Metals and Mining sector by choosing the highest returning stock. However, this can be deceiving as each company has varying costs of equity and debt levels, which could exaggeratedly push up ROE at the same time as accumulating high interest expense.
Return on Equity = Net Profit ÷ Shareholders Equity
ROE is measured against cost of equity in order to determine the efficiency of Public Stock Company VSMPO-AVISMA’s equity capital deployed. Its cost of equity is 14.35%. This means Public Stock Company VSMPO-AVISMA’s returns actually do not cover its own cost of equity, with a discrepancy of -0.44%. 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 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. Asset turnover shows how much revenue Public Stock Company VSMPO-AVISMA 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. 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 Public Stock Company VSMPO-AVISMA’s debt-to-equity ratio to examine sustainability of its returns. The most recent ratio is 50.53%, which is sensible and indicates Public Stock Company VSMPO-AVISMA 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.
ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. Public Stock Company VSMPO-AVISMA exhibits a weak ROE against its peers, as well as insufficient levels to cover its own cost of equity this year. 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 Public Stock Company VSMPO-AVISMA, there are three key factors 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 Public Stock Company VSMPO-AVISMA 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 Public Stock Company VSMPO-AVISMA is currently mispriced by the market.
- 3. Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Public Stock Company VSMPO-AVISMA? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!