Will Grenobloise d’Electronique et d’Automatismes Société Anonyme (EPA:GEA) Continue To Underperform Its Industry?

Brandy Kinsey

Updated Sun, Apr 1, 2018, 1:39 AM

Grenobloise d’Electronique et d’Automatismes Société Anonyme’s (ENXTPA:GEA) most recent return on equity was a substandard 8.13% relative to its industry performance of 8.48% over the past year. GEA’s results could indicate a relatively inefficient operation to its peers, and while this may be the case, it is important to understand what ROE is made up of and how it should be interpreted. Knowing these components could change your view on GEA’s performance. Today I will look at how components such as financial leverage can influence ROE which may impact the sustainability of GEA’s returns. View our latest analysis for Grenobloise d’Electronique et d’Automatismes Société Anonyme

Breaking down Return on Equity

Return on Equity (ROE) weighs Grenobloise d’Electronique et d’Automatismes Société Anonyme’s profit against the level of its shareholders’ equity. For example, if the company invests €1 in the form of equity, it will generate €0.08 in earnings from this. While a higher ROE is preferred in most cases, there are several other factors we should consider before drawing 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 Grenobloise d’Electronique et d’Automatismes Société Anonyme, which is 8.18%. This means Grenobloise d’Electronique et d’Automatismes Société Anonyme’s returns actually do not cover its own cost of equity, with a discrepancy of -0.052%. 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 split up into three useful 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

The first component is profit margin, which measures how much of sales is retained after the company pays for all its expenses. Asset turnover shows how much revenue Grenobloise d’Electronique et d’Automatismes Société Anonyme can generate with its current 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 financial leverage can artificially inflate ROE, we need to look at how much debt Grenobloise d’Electronique et d’Automatismes Société Anonyme currently has. Currently Grenobloise d’Electronique et d’Automatismes Société Anonyme has virtually no debt, which means its returns are predominantly driven by equity capital. This could explain why Grenobloise d’Electronique et d’Automatismes Société Anonyme’s’ ROE is lower than its industry peers, most of which may have some degree of debt in its business.

Next Steps:

While ROE is a relatively simple calculation, it can be broken down into different ratios, each telling a different story about the strengths and weaknesses of a company. Grenobloise d’Electronique et d’Automatismes Société Anonyme’s below-industry ROE is disappointing, furthermore, its returns were not even high enough to cover its own cost of equity. Although, its appropriate level of leverage means investors can be more confident in the sustainability of Grenobloise d’Electronique et d’Automatismes Société Anonyme’s return with a possible increase should the company decide to increase its debt levels. Although ROE can be a useful metric, it is only a small part of diligent research.

For Grenobloise d’Electronique et d’Automatismes Société Anonyme, I’ve put together three essential factors you should further examine:

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.
Valuation: What is Grenobloise d’Electronique et d’Automatismes Société Anonyme worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether Grenobloise d’Electronique et d’Automatismes Société Anonyme is currently mispriced by the market.
Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Grenobloise d’Electronique et d’Automatismes Société Anonyme? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!

To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned.

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