With an ROE of 42.71%, Las Vegas Sands Corp (NYSE:LVS) outpaced its own industry which delivered a less exciting 11.21% over the past year. But what is more interesting is whether LVS can sustain this above-average ratio. A measure of sustainable returns is LVS’s financial leverage. If LVS borrows debt to invest in its business, its profits will be higher. But ROE does not capture any debt, so we only see high profits and low equity, which is great on the surface. But today let’s take a deeper dive below this surface. Check out our latest analysis for Las Vegas Sands
Peeling the layers of ROE – trisecting a company’s profitability
Return on Equity (ROE) is a measure of Las Vegas Sands’s profit relative to its shareholders’ equity. For example, if the company invests $1 in the form of equity, it will generate $0.43 in earnings from this. Investors that are diversifying their portfolio based on industry may want to maximise their return in the Casinos and Gaming 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 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 Las Vegas Sands, which is 9.84%. This means Las Vegas Sands returns enough to cover its own cost of equity, with a buffer of 32.87%. This sustainable practice implies that the company pays less 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:
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 Las Vegas Sands’s asset base. Finally, financial leverage will be our main focus today. It shows how much of assets are funded by equity and can show how sustainable the company’s capital structure is. We can determine if Las Vegas Sands’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 Las Vegas Sands’s debt-to-equity ratio. The most recent ratio is 126.26%, which is relatively proportionate and indicates Las Vegas Sands has not taken on extreme leverage. Thus, we can conclude its above-average ROE is generated from its capacity to increase profit without a massive debt burden.
Next Steps:
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. Las Vegas Sands exhibits a strong ROE against its peers, as well as sufficient returns to cover its cost of equity. Its high ROE is not likely to be driven by high debt. Therefore, investors may have more confidence in the sustainability of this level of returns going forward. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.
For Las Vegas Sands, I’ve compiled three key aspects 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. Valuation: What is Las Vegas Sands 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 Las Vegas Sands is currently mispriced by the market.
- 3. Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Las Vegas Sands? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!