In This Article:
International Consolidated Airlines Group SA. (LSE:IAG) outperformed the Airlines industry on the basis of its ROE – producing a higher 27.33% relative to the peer average of 20.28% over the past 12 months. On the surface, this looks fantastic since we know that IAG has made large profits from little equity capital; however, ROE doesn’t tell us if management have borrowed heavily to make this happen. In this article, we’ll closely examine some factors like financial leverage to evaluate the sustainability of IAG’s ROE. Check out our latest analysis for International Consolidated Airlines Group
What you must know about ROE
Return on Equity (ROE) weighs International Consolidated Airlines Group’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. 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
Returns are usually compared to costs to measure the efficiency of capital. International Consolidated Airlines Group’s cost of equity is 9.15%. Given a positive discrepancy of 18.17% between return and cost, this indicates that International Consolidated Airlines Group pays less for its capital than what it generates in return, which is a sign of capital efficiency. 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
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 International Consolidated Airlines Group’s asset base. And finally, financial leverage is simply how much of assets are funded by equity, which exhibits how sustainable the company’s capital structure is. Since ROE can be inflated by excessive debt, we need to examine International Consolidated Airlines Group’s debt-to-equity level. The debt-to-equity ratio currently stands at a balanced 99.12%, meaning the above-average ROE is due to its capacity to produce profit growth without a huge debt burden.