This analysis is intended to introduce important early concepts to people who are starting to invest and want a simplistic look at the return on OGE Energy Corp (NYSE:OGE) stock.
OGE Energy Corp (NYSE:OGE) outperformed the electric utilities industry on the basis of its ROE – producing a higher 16.61% relative to the peer average of 9.12% over the past 12 months. However, whether this above-industry ROE is actually impressive depends on if it can be maintained. A measure of sustainable returns is OGE’s financial leverage. If OGE borrows debt to invest in its business, its profits will be higher. But ROE does not capture any debt, so we only see high profits and low equity, which is great on the surface. But today let’s take a deeper dive below this surface. Check out our latest analysis for OGE Energy
Breaking down ROE — the mother of all ratios
Return on Equity (ROE) weighs OGE Energy’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. If investors diversify their portfolio by industry, they may want to maximise their return in the Electric Utilities 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.
Return on Equity = Net Profit ÷ Shareholders Equity
ROE is measured against cost of equity in order to determine the efficiency of OGE Energy’s equity capital deployed. Its cost of equity is 8.59%. Since OGE Energy’s return covers its cost in excess of 8.02%, its use of equity capital is efficient and likely to be sustainable. Simply put, OGE Energy pays less 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 OGE Energy can generate with its current asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. We can determine if OGE Energy’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 OGE Energy’s debt-to-equity ratio. Currently the ratio stands at 83.12%, which is reasonable. This means OGE Energy has not taken on too much leverage, and its above-average ROE is driven by its ability to grow its profit without a huge debt burden.
ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. OGE Energy exhibits a strong ROE against its peers, as well as sufficient returns to cover its cost of equity. ROE is not likely to be inflated by excessive debt funding, giving shareholders more conviction in the sustainability of high returns. Although ROE can be a useful metric, it is only a small part of diligent research.
For OGE Energy, I’ve put together three relevant aspects 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.
- Future Earnings: How does OGE Energy’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 OGE Energy? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!