This analysis is intended to introduce important early concepts to people who are starting to invest and looking to gauge the potential return on investment in Sociedad Química y Minera de Chile SA (NYSE:SQM).
Sociedad Química y Minera de Chile SA (NYSE:SQM) delivered an ROE of 19.50% over the past 12 months, which is an impressive feat relative to its industry average of 13.85% during the same period. But what is more interesting is whether SQM can sustain this above-average ratio. This can be measured by looking at the company’s financial leverage. With more debt, SQM 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. See our latest analysis for Sociedad Química y Minera de Chile
What you must know about ROE
Return on Equity (ROE) weighs Sociedad Química y Minera de Chile’s profit against the level of its shareholders’ equity. For example, if the company invests $1 in the form of equity, it will generate $0.19 in earnings from this. Investors seeking to maximise their return in the Fertilizers and Agricultural Chemicals 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 Sociedad Química y Minera de Chile 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. Sociedad Química y Minera de Chile’s cost of equity is 8.93%. This means Sociedad Química y Minera de Chile returns enough to cover its own cost of equity, with a buffer of 10.57%. This sustainable practice implies that the company pays less 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
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 Sociedad Química y Minera de Chile can generate with its current 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 Sociedad Química y Minera de Chile’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 Sociedad Química y Minera de Chile’s debt-to-equity ratio. Currently the ratio stands at 52.10%, which is reasonable. This means Sociedad Química y Minera de Chile has not taken on too much leverage, and its above-average ROE is driven by its ability to grow its profit without a huge debt burden.
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. Sociedad Química y Minera de Chile’s ROE is impressive relative to the industry average and also covers 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. Although ROE can be a useful metric, it is only a small part of diligent research.
For Sociedad Química y Minera de Chile, there are three important factors you should further examine:
- 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 Sociedad Química y Minera de Chile 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 Sociedad Química y Minera de Chile is currently mispriced by the market.
- Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Sociedad Química y Minera de Chile? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!