JW Mays Inc’s (NASDAQ:MAYS) most recent return on equity was a substandard 3.79% relative to its industry performance of 7.99% over the past year. Though MAYS'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 MAYS's below-average returns. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of MAYS's returns. Let me show you what I mean by this. View our latest analysis for J.W. Mays
What you must know about ROE
Return on Equity (ROE) weighs MAYS’s profit against the level of its shareholders’ equity. It essentially shows how much MAYS 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
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 MAYS, which is 9.04%. Since MAYS’s return does not cover its cost, with a difference of -5.25%, this means its current use of equity is not efficient and not sustainable. Very simply, MAYS 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
Basically, profit margin measures how much of revenue trickles down into earnings which illustrates how efficient MAYS is with its cost management. Asset turnover reveals how much revenue can be generated from MAYS’s asset base. And finally, financial leverage is simply how much of assets are funded by equity, which exhibits how sustainable MAYS’s capital structure is. Since financial leverage can artificially inflate ROE, we need to look at how much debt MAYS currently has. Currently the debt-to-equity ratio stands at a low 11.35%, which means MAYS still has headroom to take on more leverage in order to increase profits.
What this means for you:
Are you a shareholder? MAYS exhibits a weak ROE against its peers, as well as insufficient levels to cover its own cost of equity this year. Since its existing ROE is not fuelled by unsustainable debt, investors shouldn’t give up as MAYS still has capacity to improve shareholder returns by borrowing to invest in new projects in the future.