Taitron Components Incorporated’s (NASDAQ:TAIT) most recent return on equity was a substandard 5.87% relative to its industry performance of 10.45% over the past year. 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 TAIT’s past performance. I will take you through how metrics such as financial leverage impact ROE which may affect the overall sustainability of TAIT’s returns. View our latest analysis for Taitron Components
Breaking down Return on Equity
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. Investors seeking to maximise their return in the Technology Distributors industry may want to choose 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 Taitron Components 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 measured against cost of equity in order to determine the efficiency of Taitron Components’s equity capital deployed. Its cost of equity is 9.55%. Given a discrepancy of -3.68% between return and cost, this indicated that Taitron Components may be paying more for its capital than what it’s generating 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
The first component is profit margin, which measures how much of sales is retained after the company pays for all its expenses. The other component, asset turnover, illustrates how much revenue Taitron Components can make from its asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. We can assess whether Taitron Components is fuelling ROE by excessively raising debt. Ideally, Taitron Components 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 4.22%, which is sensible and indicates Taitron Components has not taken on too much leverage. Thus, we can conclude its below-average ROE may be a result of low debt, and Taitron Components still has room to increase leverage and grow future returns.
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. Taitron Components’s ROE is underwhelming relative to the industry average, and its returns were also not strong 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. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.
For Taitron Components, there are three pertinent aspects you should look at:
- 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.
- Future Earnings: How does Taitron Components’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.
- Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Taitron Components? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!