Wilhelmina International Inc’s (NASDAQ:WHLM) most recent return on equity was a substandard 1.43% relative to its industry performance of 12.04% 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 WHLM’s past performance. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of WHLM’s returns. Let me show you what I mean by this. View our latest analysis for Wilhelmina International
Breaking down Return on Equity
Return on Equity (ROE) is a measure of Wilhelmina International’s profit relative to its shareholders’ equity. An ROE of 1.43% implies $0.01 returned on every $1 invested, so the higher the return, the better. Investors seeking to maximise their return in the Diversified Support Services 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 Wilhelmina International 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 Wilhelmina International, which is 8.49%. This means Wilhelmina International’s returns actually do not cover its own cost of equity, with a discrepancy of -7.07%. 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 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
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 Wilhelmina International 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 Wilhelmina International’s debt-to-equity ratio to examine sustainability of its returns. The most recent ratio is 7.61%, which is sensible and indicates Wilhelmina International has not taken on too much leverage. Thus, we can conclude its below-average ROE may be a result of low debt, and Wilhelmina International still has room to increase leverage and grow future returns.
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. Wilhelmina International’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 Wilhelmina International, I’ve put together three essential 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 Wilhelmina International 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 Wilhelmina International is currently mispriced by the market.
- Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Wilhelmina International? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!