Did Cabot Microelectronics Corporation (NASDAQ:CCMP) Create Value For Investors Over The Past Year?

Cabot Microelectronics Corporation (NASDAQ:CCMP) performed in line with its semiconductor equipment industry on the basis of its ROE – producing a return of10.25% relative to the peer average of 12.39% over the past 12 months. But what is more interesting is whether CCMP can sustain or improve on this level of return. Today I will look at how components such as financial leverage can influence ROE which may impact the sustainability of CCMP's returns. Check out our latest analysis for Cabot Microelectronics

Breaking down ROE — the mother of all ratios

Return on Equity (ROE) is a measure of Cabot Microelectronics’s profit relative to its shareholders’ equity. For example, if the company invests $1 in the form of equity, it will generate $0.1 in earnings from this. If investors diversify their portfolio by industry, they may want to maximise their return in the Semiconductor Equipment 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.

Returns are usually compared to costs to measure the efficiency of capital. Cabot Microelectronics’s cost of equity is 10.03%. Some of Cabot Microelectronics’s peers may have a higher ROE but its cost of equity could exceed this return, leading to an unsustainable negative discrepancy i.e. the company spends more than it earns. This is not the case for Cabot Microelectronics which is reassuring. ROE can be dissected into three distinct ratios: net profit margin, asset turnover, and financial leverage. This is called the Dupont Formula:

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 Cabot Microelectronics’s asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. ROE can be inflated by disproportionately high levels of debt. This is also unsustainable due to the high interest cost that the company will also incur. Thus, we should look at Cabot Microelectronics’s debt-to-equity ratio to examine sustainability of its returns. Currently the ratio stands at 23.39%, which is very low. This means Cabot Microelectronics has not taken on leverage, which could explain its below-average ROE. Cabot Microelectronics still has headroom to take on more leverage in order to grow its returns.

Next Steps:

While ROE is a relatively simple calculation, it can be broken down into different ratios, each telling a different story about the strengths and weaknesses of a company. Even though Cabot Microelectronics returned below the industry average, its ROE comes in excess of its cost of equity. Also, 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. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.

For Cabot Microelectronics, there are three fundamental factors 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 Cabot Microelectronics 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 Cabot Microelectronics is currently mispriced by the market.
3. Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Cabot Microelectronics? 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.