This analysis is intended to introduce important early concepts to people who are starting to invest and want to better understand how you can grow your money by investing in Nam Tai Property Inc (NYSE:NTP).
Nam Tai Property Inc (NYSE:NTP) delivered a less impressive 1.84% ROE over the past year, compared to the 10.60% return generated by its industry. An investor may attribute an inferior ROE to a relatively inefficient performance, and whilst this can often be the case, knowing the nuts and bolts of the ROE calculation may change that perspective and give you a deeper insight into NTP’s past performance. Today I will look at how components such as financial leverage can influence ROE which may impact the sustainability of NTP’s returns. See our latest analysis for Nam Tai Property
What you must know about ROE
Return on Equity (ROE) is a measure of Nam Tai Property’s profit relative to its shareholders’ equity. For example, if the company invests $1 in the form of equity, it will generate $0.018 in earnings from this. Investors that are diversifying their portfolio based on industry may want to maximise their return in the Real Estate Operating Companies sector by choosing the highest returning stock. However, this can be misleading as each firm has different costs of equity and debt levels i.e. the more debt Nam Tai Property has, the higher ROE is pumped up in the short term, at the expense of long term interest payment burden.
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 Nam Tai Property, which is 8.59%. Since Nam Tai Property’s return does not cover its cost, with a difference of -6.75%, this means its current use of equity is not efficient and not sustainable. Very simply, Nam Tai Property 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
Essentially, profit margin shows how much money the company makes after paying for all its expenses. Asset turnover reveals how much revenue can be generated from Nam Tai Property’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 determine if Nam Tai Property’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 Nam Tai Property’s debt-to-equity ratio. Currently, Nam Tai Property has no debt which means its returns are driven purely by equity capital. This could explain why Nam Tai Property’s’ ROE is lower than its industry peers, most of which may have some degree of debt in its business.
ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. Nam Tai Property’s ROE is underwhelming relative to the industry average, and its returns were also not strong enough to cover its own cost of equity. Although, its appropriate level of leverage means investors can be more confident in the sustainability of Nam Tai Property’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 Nam Tai Property, there are three pertinent factors 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 Nam Tai Property 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 Nam Tai Property is currently mispriced by the market.
- Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Nam Tai Property? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!