Beacon Roofing Supply Inc (NASDAQ:BECN) generated a below-average return on equity of 7.99% in the past 12 months, while its industry returned 12.22%. BECN’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 BECN’s performance. I will take you through how metrics such as financial leverage impact ROE which may affect the overall sustainability of BECN’s returns. View our latest analysis for Beacon Roofing Supply
What you must know about ROE
Return on Equity (ROE) weighs Beacon Roofing Supply’s profit against the level of its shareholders’ equity. For example, if the company invests $1 in the form of equity, it will generate $0.08 in earnings from this. Investors that are diversifying their portfolio based on industry may want to maximise their return in the Trading Companies and Distributors 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
ROE is measured against cost of equity in order to determine the efficiency of Beacon Roofing Supply’s equity capital deployed. Its cost of equity is 9.59%. Given a discrepancy of -1.60% between return and cost, this indicated that Beacon Roofing Supply 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
Essentially, profit margin shows how much money the company makes after paying for all its expenses. Asset turnover reveals how much revenue can be generated from Beacon Roofing Supply’s asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. We can determine if Beacon Roofing Supply’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 Beacon Roofing Supply’s debt-to-equity ratio. The most recent ratio is 110.02%, which is relatively proportionate and indicates Beacon Roofing Supply has not taken on extreme leverage. Thus, we can conclude its current ROE is generated from its capacity to increase profit without a massive 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. Beacon Roofing Supply’s below-industry ROE is disappointing, furthermore, its returns were not even high 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 Beacon Roofing Supply, there are three pertinent factors 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.
- Valuation: What is Beacon Roofing Supply 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 Beacon Roofing Supply is currently mispriced by the market.
- Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Beacon Roofing Supply? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!