Gramercy Property Trust’s (NYSE:GPT) most recent return on equity was a substandard 2.65% relative to its industry performance of 7.33% over the past year. Though GPT’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 GPT’s below-average returns. I will take you through how metrics such as financial leverage impact ROE which may affect the overall sustainability of GPT’s returns. View our latest analysis for Gramercy Property Trust
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. If investors diversify their portfolio by industry, they may want to maximise their return in the Diversified REITs sector by investing in 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. Gramercy Property Trust’s cost of equity is 9.00%. This means Gramercy Property Trust’s returns actually do not cover its own cost of equity, with a discrepancy of -6.35%. 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 dissected into three distinct 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 Gramercy Property Trust 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 Gramercy Property Trust is fuelling ROE by excessively raising debt. Ideally, Gramercy Property Trust should have a balanced capital structure, which we can check by looking at the historic debt-to-equity ratio of the company. Currently the ratio stands at 88.12%, which is reasonable. This means Gramercy Property Trust has not taken on too much leverage, and its current 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. Gramercy Property Trust exhibits a weak ROE against its peers, as well as insufficient levels to cover its own cost of equity this year. Although, its appropriate level of leverage means investors can be more confident in the sustainability of Gramercy Property Trust’s return with a possible increase should the company decide to increase its debt levels. Although ROE can be a useful metric, it is only a small part of diligent research.
For Gramercy Property Trust, I’ve put together three fundamental 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 Gramercy Property Trust 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 Gramercy Property Trust is currently mispriced by the market.
- 3. Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Gramercy Property Trust? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!