This article is intended for those of you who are at the beginning of your investing journey and want a simplistic look at the return on National Presto Industries Inc (NYSE:NPK) stock.
National Presto Industries Inc (NYSE:NPK) delivered an ROE of 13.19% over the past 12 months, which is relatively in-line with its industry average of 13.69% during the same period. But what is more interesting is whether NPK can sustain or improve on this level of return. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of NPK’s returns. Let me show you what I mean by this. Check out our latest analysis for National Presto Industries
Breaking down ROE — the mother of all ratios
Return on Equity (ROE) is a measure of National Presto Industries’s profit relative to its shareholders’ equity. An ROE of 13.19% implies $0.13 returned on every $1 invested, so the higher the return, the better. Investors seeking to maximise their return in the Aerospace and Defense 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 National Presto Industries 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
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 National Presto Industries, which is 9.08%. Some of National Presto Industries’s peers may have a higher ROE but its cost of equity could exceed this return, leading to an unsustainable negative discrepancy i.e. the company spends more than it earns. This is not the case for National Presto Industries which is reassuring. 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. Asset turnover shows how much revenue National Presto Industries 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 National Presto Industries’s debt-to-equity ratio to examine sustainability of its returns. Currently, National Presto Industries has no debt which means its returns are driven purely by equity capital. This could explain why National Presto Industries’s’ ROE is lower than its industry peers, most of which may have some degree of debt in its business.
ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. Even though National Presto Industries returned below the industry average, its ROE comes in excess of its cost of equity. Its appropriate level of leverage means investors can be more confident in the sustainability of National Presto Industries’s return with a possible increase should the company decide to increase its debt levels. Although ROE can be a useful metric, it is only a small part of diligent research.
For National Presto Industries, I’ve put together three key aspects 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 National Presto Industries 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 National Presto Industries is currently mispriced by the market.
- Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of National Presto Industries? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!