In This Article:
This article is intended for those of you who are at the beginning of your investing journey and looking to gauge the potential return on investment in Ingenia Communities Group (ASX:INA).
Ingenia Communities Group (ASX:INA) delivered a less impressive 6.84% ROE over the past year, compared to the 13.18% return generated by its industry. Though INA’s recent performance is underwhelming, it is useful to understand what ROE is made up of and how it should be interpreted. Knowing these components can change your views on INA’s below-average returns. Today I will look at how components such as financial leverage can influence ROE which may impact the sustainability of INA’s returns. View out our latest analysis for Ingenia Communities Group
Breaking down ROE — the mother of all ratios
Return on Equity (ROE) is a measure of Ingenia Communities Group’s profit relative to its shareholders’ equity. An ROE of 6.84% implies A$0.068 returned on every A$1 invested. 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 Ingenia Communities Group, which is 8.55%. Given a discrepancy of -1.71% between return and cost, this indicated that Ingenia Communities Group may be paying more for its capital than what it’s generating 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
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 shows how much revenue Ingenia Communities Group can generate with its current 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 artificially increased through excessive borrowing, we should check Ingenia Communities Group’s historic debt-to-equity ratio. At 45.00%, Ingenia Communities Group’s debt-to-equity ratio appears sensible and indicates its ROE is generated from its capacity to increase profit without a large debt burden.