Enbridge Energy Partners LP (NYSE:EEP) performed in-line with its oil and gas storage and transportation industry on the basis of its ROE – producing a return of9.19% relative to the peer average of 9.06% over the past 12 months. However, whether this ROE is actually impressive depends on if it can be maintained. Sustainability can be gauged by a company’s financial leverage – the more debt it has, the higher ROE is pumped up in the short term, at the expense of long term interest payment burden. Let me show you what I mean by this. See our latest analysis for Enbridge Energy Partners
Peeling the layers of ROE – trisecting a company’s profitability
Return on Equity (ROE) weighs Enbridge Energy Partners’s profit against the level of its shareholders’ equity. For example, if the company invests $1 in the form of equity, it will generate $0.09 in earnings from this. Investors that are diversifying their portfolio based on industry may want to maximise their return in the Oil and Gas Storage and Transportation sector by choosing 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 Enbridge Energy Partners 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 measured against cost of equity in order to determine the efficiency of Enbridge Energy Partners’s equity capital deployed. Its cost of equity is 12.99%. Since Enbridge Energy Partners’s return does not cover its cost, with a difference of -3.80%, this means its current use of equity is not efficient and not sustainable. Very simply, Enbridge Energy Partners pays more for its capital than what it generates in return. ROE can be split up into three useful 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 Enbridge Energy Partners can generate with its current asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. We can assess whether Enbridge Energy Partners is fuelling ROE by excessively raising debt. Ideally, Enbridge Energy Partners should have a balanced capital structure, which we can check by looking at the historic debt-to-equity ratio of the company. The ratio currently stands at a balanced 111.27%, meaning Enbridge Energy Partners has not taken on excessively disproportionate debt to drive its returns. The company is able to produce profit growth without a substantial debt burden.
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. Enbridge Energy Partners exhibits a strong ROE against its peers, however it was not high enough to cover its own cost of equity this year. Although ROE can be a useful metric, it is only a small part of diligent research.
For Enbridge Energy Partners, I’ve compiled three fundamental aspects 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. Future Earnings: How does Enbridge Energy Partners’s growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
3. Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Enbridge Energy Partners? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!