Money3 Corporation Limited (ASX:MNY) delivered an ROE of 17.18% over the past 12 months, which is an impressive feat relative to its industry average of 15.40% during the same period. On the surface, this looks fantastic since we know that MNY has made large profits from little equity capital; however, ROE doesn’t tell us if management have borrowed heavily to make this happen. We’ll take a closer look today at factors like financial leverage to determine whether MNY’s ROE is actually sustainable. View our latest analysis for Money3
Breaking down ROE — the mother of all ratios
Return on Equity (ROE) is a measure of MNY’s profit relative to its shareholders’ equity. For example, if MNY invests A$1 in the form of equity, it will generate A$0.17 in earnings from this. In most cases, a higher ROE is preferred; however, there are many other factors we must consider prior to making any investment decisions.
Return on Equity = Net Profit ÷ Shareholders Equity
ROE is measured against cost of equity in order to determine the efficiency of MNY’s equity capital deployed. Its cost of equity is 8.55%. Since MNY’s return covers its cost in excess of 8.63%, its use of equity capital is efficient and likely to be sustainable. Simply put, MNY 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:
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 MNY is with its cost management. Asset turnover reveals how much revenue can be generated from MNY’s 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 MNY’s capital structure is. Since ROE can be inflated by excessive debt, we need to examine MNY’s debt-to-equity level. At 43.67%, MNY’s debt-to-equity ratio appears low and indicates the above-average ROE is generated from its capacity to increase profit without a large debt burden.
What this means for you:
Are you a shareholder? MNY exhibits a strong ROE against its peers, as well as sufficient returns to cover its cost of equity. Since ROE is not inflated by excessive debt, it might be a good time to add more of MNY to your portfolio if your personal research is confirming what the ROE is telling you. If you’re looking for new ideas for high-returning stocks, you should take a look at our free platform to see the list of stocks with Return on Equity over 20%.