The Liberty SiriusXM Group (NASDAQ:LSXM.K) delivered a less impressive 5.18% ROE over the past year, compared to the 11.27% return generated by its industry. Though LSXM.K’s recent performance is underwhelming, it is useful to understand what ROE is made up of and how it should be interpreted. Knowing these components can change your views on LSXM.K’s below-average returns. I will take you through how metrics such as financial leverage impact ROE which may affect the overall sustainability of LSXM.K’s returns. See our latest analysis for Liberty SiriusXM Group
Peeling the layers of ROE – trisecting a company’s profitability
Return on Equity (ROE) is a measure of Liberty SiriusXM Group’s profit relative to its shareholders’ equity. An ROE of 5.18% implies $0.05 returned on every $1 invested, so the higher the return, the better. If investors diversify their portfolio by industry, they may want to maximise their return in the Cable and Satellite sector by investing in 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 measured against cost of equity in order to determine the efficiency of Liberty SiriusXM Group’s equity capital deployed. Its cost of equity is 10.74%. This means Liberty SiriusXM Group’s returns actually do not cover its own cost of equity, with a discrepancy of -5.56%. This isn’t sustainable as it implies, very simply, that the company 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
Basically, profit margin measures how much of revenue trickles down into earnings which illustrates how efficient the business is with its cost management. The other component, asset turnover, illustrates how much revenue Liberty SiriusXM Group can make from its 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 assess whether Liberty SiriusXM Group is fuelling ROE by excessively raising debt. Ideally, Liberty SiriusXM Group 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 sensible 43.98%, meaning Liberty SiriusXM Group has not taken on excessive debt to drive its returns. The company is able to produce profit growth without a huge debt burden and still has headroom to grow returns to industry average.
ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. Liberty SiriusXM Group exhibits a weak ROE against its peers, as well as insufficient levels to cover its own cost of equity this year. However, ROE is not likely to be inflated by excessive debt funding, giving shareholders more conviction in the sustainability of returns, which has headroom to increase further. Although ROE can be a useful metric, it is only a small part of diligent research.
For Liberty SiriusXM Group, I’ve compiled three essential aspects you should further research:
- 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 Liberty SiriusXM Group 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 Liberty SiriusXM Group is currently mispriced by the market.
- 3. Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Liberty SiriusXM Group? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!