With An ROE Of 0.28%, Can Twitter Inc (NYSE:TWTR) Catch Up To The Industry?

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 Twitter Inc (NYSE:TWTR).

Twitter Inc’s (NYSE:TWTR) most recent return on equity was a substandard 0.28% relative to its industry performance of 12.67% over the past year. TWTR's results could indicate a relatively inefficient operation to its peers, and while this may be the case, it is important to understand what ROE is made up of and how it should be interpreted. Knowing these components could change your view on TWTR’s performance. Today I will look at how components such as financial leverage can influence ROE which may impact the sustainability of TWTR's returns. View out our latest analysis for Twitter

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 0.28% implies $0.0028 returned on every $1 invested, so the higher the return, the better. Investors seeking to maximise their return in the Internet Software and Services 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

ROE is assessed against cost of equity, which is measured using the Capital Asset Pricing Model (CAPM) – but let’s not dive into the details of that today. For now, let’s just look at the cost of equity number for Twitter, which is 12.31%. Since Twitter’s return does not cover its cost, with a difference of -12.03%, this means its current use of equity is not efficient and not sustainable. Very simply, Twitter pays more for its capital than what it generates in return. ROE can be dissected into three distinct 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

The first component is profit margin, which measures how much of sales is retained after the company pays for all its expenses. Asset turnover reveals how much revenue can be generated from Twitter’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 assess whether Twitter is fuelling ROE by excessively raising debt. Ideally, Twitter 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 34.71%, meaning Twitter 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.

Next Steps:

ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. Twitter’s ROE is underwhelming relative to the industry average, and its returns were also not strong enough to cover its own cost of equity. 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 Twitter, I've put together three essential 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. Valuation: What is Twitter 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 Twitter is currently mispriced by the market.
3. Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Twitter? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!

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Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.