The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and looking to gauge the potential return on investment in Westlake Chemical Partners LP (NYSE:WLKP).
With an ROE of 35.65%, Westlake Chemical Partners LP (NYSE:WLKP) outpaced its own industry which delivered a less exciting 13.93% over the past year. However, whether this above-industry ROE is actually impressive depends on if it can be maintained. A measure of sustainable returns is WLKP’s financial leverage. If WLKP 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. See our latest analysis for Westlake Chemical Partners
What you must know about ROE
Firstly, Return on Equity, or ROE, is simply the percentage of last years’ earning against the book value of shareholders’ equity. An ROE of 35.65% implies $0.36 returned on every $1 invested, so the higher the return, the better. Investors seeking to maximise their return in the Commodity Chemicals industry may want to choose the highest returning stock. However, this can be deceiving as each company has varying costs of equity and debt levels, which could exaggeratedly push up ROE at the same time as accumulating high interest expense.
Return on Equity = Net Profit ÷ Shareholders Equity
Returns are usually compared to costs to measure the efficiency of capital. Westlake Chemical Partners’s cost of equity is 11.16%. This means Westlake Chemical Partners returns enough to cover its own cost of equity, with a buffer of 24.49%. 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:
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 Westlake Chemical Partners’s 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. We can determine if Westlake Chemical Partners’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 Westlake Chemical Partners’s debt-to-equity ratio. The ratio currently stands at a sensible 48.97%, meaning Westlake Chemical Partners has not taken on excessive debt to drive its returns. The company is able to produce profit growth without a huge debt burden.
ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. Westlake Chemical Partners’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. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.
For Westlake Chemical Partners, I’ve put together three essential aspects 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 Westlake Chemical Partners 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 Westlake Chemical Partners is currently mispriced by the market.
- Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Westlake Chemical 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!