Uni-Select Inc (TSX:UNS) outperformed the Distributors industry on the basis of its ROE – producing a higher 9.95% relative to the peer average of 5.59% over the past 12 months. While the impressive ratio tells us that UNS has made significant profits from little equity capital, ROE doesn’t tell us if UNS has borrowed debt to make this happen. We’ll take a closer look today at factors like financial leverage to determine whether UNS’s ROE is actually sustainable. See our latest analysis for Uni-Select
What you must know about ROE
Return on Equity (ROE) weighs Uni-Select’s profit against the level of its shareholders’ equity. For example, if the company invests CA$1 in the form of equity, it will generate CA$0.1 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 Uni-Select’s equity capital deployed. Its cost of equity is 9.58%. This means Uni-Select returns enough to cover its own cost of equity, with a buffer of 0.37%. This sustainable practice implies that the company pays less 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:
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. The other component, asset turnover, illustrates how much revenue Uni-Select can make from its 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 the company’s capital structure is. Since ROE can be inflated by excessive debt, we need to examine Uni-Select’s debt-to-equity level. The debt-to-equity ratio currently stands at a balanced 97.19%, meaning the above-average ROE is due to its capacity to produce profit growth without a huge debt burden.
What this means for you:
Are you a shareholder? UNS’s above-industry ROE is encouraging, and is also in excess of its cost of equity. Since ROE is not inflated by excessive debt, it might be a good time to add more of UNS 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%.