This analysis is intended to introduce important early concepts to people who are starting to invest and want a simplistic look at the return on CorePoint Lodging Inc (NYSE:CPLG) stock.
CorePoint Lodging Inc (NYSE:CPLG) outperformed the hotel and resort reits industry on the basis of its ROE – producing a higher 16.83% relative to the peer average of 7.63% over the past 12 months. However, whether this above-industry ROE is actually impressive depends on if it can be maintained. This can be measured by looking at the company’s financial leverage. With more debt, CPLG 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 CorePoint Lodging
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. It essentially shows how much the company can generate in earnings given the amount of equity it has raised. Investors seeking to maximise their return in the Hotel and Resort REITs 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 measured against cost of equity in order to determine the efficiency of CorePoint Lodging’s equity capital deployed. Its cost of equity is 9.53%. This means CorePoint Lodging returns enough to cover its own cost of equity, with a buffer of 7.30%. 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
The first component is profit margin, which measures how much of sales is retained after the company pays for all its expenses. Asset turnover shows how much revenue CorePoint Lodging can generate with its current asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. We can assess whether CorePoint Lodging is fuelling ROE by excessively raising debt. Ideally, CorePoint Lodging 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 high 209.43%, meaning CorePoint Lodging may have taken on a disproportionate level of debt which is driving the high return. The company’s ability to produce profit growth may hinge on its big debt burden.
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. CorePoint Lodging’s above-industry ROE is encouraging, and is also in excess of its cost of equity. Its high debt level means its strong ROE may be driven by debt funding which raises concerns over the sustainability of CorePoint Lodging’s returns. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.
For CorePoint Lodging, I’ve put together three fundamental aspects 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 CorePoint Lodging’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 CorePoint Lodging? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!