Fidelity National Information Services Inc’s (NYSE:FIS) most recent return on equity was a substandard 5.75% relative to its industry performance of 13.88% over the past year. Though FIS’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 FIS’s below-average returns. Today I will look at how components such as financial leverage can influence ROE which may impact the sustainability of FIS’s returns. Check out our latest analysis for Fidelity National Information Services
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. For example, if the company invests $1 in the form of equity, it will generate $0.06 in earnings from this. Investors seeking to maximise their return in the Data Processing and Outsourced Services industry may want to choose the highest returning stock. But this can be misleading as each company has different costs of equity and also varying debt levels, which could artificially push up ROE whilst accumulating high interest expense.
Return on Equity = Net Profit ÷ Shareholders Equity
Returns are usually compared to costs to measure the efficiency of capital. Fidelity National Information Services’s cost of equity is 10.14%. This means Fidelity National Information Services’s returns actually do not cover its own cost of equity, with a discrepancy of -4.39%. 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 broken down into three different 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 shows how much revenue Fidelity National Information Services can generate with its current 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 Fidelity National Information Services is fuelling ROE by excessively raising debt. Ideally, Fidelity National Information Services should have a balanced capital structure, which we can check by looking at the historic debt-to-equity ratio of the company. The most recent ratio is 90.29%, which is relatively proportionate and indicates Fidelity National Information Services has not taken on extreme leverage. Thus, we can conclude its current ROE is generated from its capacity to increase profit without a massive debt burden.
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. Fidelity National Information Services’s below-industry ROE is disappointing, furthermore, its returns were not even high 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 Fidelity National Information Services, I’ve compiled three fundamental aspects you should further examine:
- 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 Fidelity National Information Services 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 Fidelity National Information Services is currently mispriced by the market.
- 3. Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Fidelity National Information Services? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!