The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want a simplistic look at the return on Panhandle Oil and Gas Inc (NYSE:PHX) stock.
Panhandle Oil and Gas Inc (NYSE:PHX) delivered an ROE of 13.15% over the past 12 months, which is relatively in-line with its industry average of 11.36% during the same period. But what is more interesting is whether PHX can sustain this level of return. This can be measured by looking at the company’s financial leverage. With more debt, PHX can invest even more and earn more money, thus pushing up its returns. However, ROE only measures returns against equity, not debt. This can be distorted, so let’s take a look at it further. Check out our latest analysis for Panhandle Oil and Gas
Breaking down Return on Equity
Return on Equity (ROE) is a measure of Panhandle Oil and Gas’s profit relative to its shareholders’ equity. It essentially shows how much the company can generate in earnings given the amount of equity it has raised. Investors that are diversifying their portfolio based on industry may want to maximise their return in the Oil and Gas Exploration and Production 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 Panhandle Oil and Gas 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
Returns are usually compared to costs to measure the efficiency of capital. Panhandle Oil and Gas’s cost of equity is 9.20%. This means Panhandle Oil and Gas returns enough to cover its own cost of equity, with a buffer of 3.95%. This sustainable practice implies that the company pays less for its capital than what it generates 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:
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 reveals how much revenue can be generated from Panhandle Oil and Gas’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 Panhandle Oil and Gas’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 Panhandle Oil and Gas’s debt-to-equity ratio. Currently the ratio stands at 33.34%, which is very low. This means Panhandle Oil and Gas has not taken on leverage, and its above-average ROE is driven by its ability to grow its profit without a huge debt burden.
Next Steps:
ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. Panhandle Oil and Gas’s above-industry ROE is encouraging, and is also in excess of its cost of equity. ROE is not likely to be inflated by excessive debt funding, giving shareholders more conviction in the sustainability of high returns. Although ROE can be a useful metric, it is only a small part of diligent research.
For Panhandle Oil and Gas, I’ve compiled three relevant factors you should look at:
- 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.
- Future Earnings: How does Panhandle Oil and Gas’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.
- Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Panhandle Oil and Gas? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!