Jobindex A/S (CPSE:JOBNDX) delivered an ROE of 91.58% over the past 12 months, which is an impressive feat relative to its industry average of 12.05% during the same period. While the impressive ratio tells us that JOBNDX has made significant profits from little equity capital, ROE doesn’t tell us if JOBNDX has borrowed debt to make this happen. Today, we’ll take a closer look at some factors like financial leverage to see how sustainable JOBNDX’s ROE is. Check out our latest analysis for Jobindex
Breaking down ROE — the mother of all ratios
Firstly, Return on Equity, or ROE, is simply the percentage of last years’ earning against the book value of shareholders’ equity. For example, if the company invests DKK1 in the form of equity, it will generate DKK0.92 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 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 Jobindex, which is 9.25%. This means Jobindex returns enough to cover its own cost of equity, with a buffer of 82.33%. This sustainable practice implies that the company 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
The first component is profit margin, which measures how much of sales is retained after the company pays for all its expenses. The other component, asset turnover, illustrates how much revenue Jobindex can make from its asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. Since ROE can be artificially increased through excessive borrowing, we should check Jobindex’s historic debt-to-equity ratio. Currently Jobindex has virtually no debt, which means its returns are predominantly driven by equity capital. Therefore, the level of financial leverage has no impact on ROE, and the ratio is a representative measure of the efficiency of all its capital employed firm-wide.