Boero Bartolomeo SpA’s (BIT:BOE) most recent return on equity was a substandard 0.15% relative to its industry performance of 4.62% 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 BOE’s past performance. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of BOE’s returns. Let me show you what I mean by this. See our latest analysis for Boero Bartolomeo
What you must know about ROE
Return on Equity (ROE) weighs Boero Bartolomeo’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. Generally speaking, a higher ROE is preferred; however, there are other factors we must also consider before making any conclusions.
Return on Equity = Net Profit ÷ Shareholders Equity
ROE is assessed against cost of equity, which is measured using the Capital Asset Pricing Model (CAPM) – but let’s not dive into the details of that today. For now, let’s just look at the cost of equity number for Boero Bartolomeo, which is 9.34%. This means Boero Bartolomeo’s returns actually do not cover its own cost of equity, with a discrepancy of -9.20%. 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:
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
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 Boero Bartolomeo’s asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. Since ROE can be artificially increased through excessive borrowing, we should check Boero Bartolomeo’s historic debt-to-equity ratio. Currently the debt-to-equity ratio stands at a low 46.30%, which means Boero Bartolomeo still has headroom to take on more leverage in order to increase profits.