With An ROE Of 1.59%, Can DASAN Zhone Solutions Inc (NASDAQ:DZSI) Catch Up To The Industry?

DASAN Zhone Solutions Inc (NASDAQ:DZSI) delivered a less impressive 1.59% ROE over the past year, compared to the 6.83% 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 DZSI's past performance. Today I will look at how components such as financial leverage can influence ROE which may impact the sustainability of DZSI's returns. See our latest analysis for DASAN Zhone Solutions

Peeling the layers of ROE – trisecting a company’s profitability

Return on Equity (ROE) weighs DASAN Zhone Solutions’s profit against the level of its shareholders’ equity. It essentially shows how much the company can generate in earnings given the amount of equity it has raised. Investors that are diversifying their portfolio based on industry may want to maximise their return in the Communications Equipment sector by choosing 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.

ROE is measured against cost of equity in order to determine the efficiency of DASAN Zhone Solutions’s equity capital deployed. Its cost of equity is 10.05%. This means DASAN Zhone Solutions’s returns actually do not cover its own cost of equity, with a discrepancy of -8.46%. 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:

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 reveals how much revenue can be generated from DASAN Zhone Solutions’s asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. We can assess whether DASAN Zhone Solutions is fuelling ROE by excessively raising debt. Ideally, DASAN Zhone Solutions 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 40.10%, which is very low. This means DASAN Zhone Solutions has not taken on leverage, which could explain its below-average ROE. DASAN Zhone Solutions 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. DASAN Zhone Solutions’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 DASAN Zhone Solutions, I've compiled three fundamental factors 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. Future Earnings: How does DASAN Zhone Solutions'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.
• 3. Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of DASAN Zhone Solutions? 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.