Match Group Inc (NASDAQ:MTCH) delivered an ROE of 88.27% over the past 12 months, which is an impressive feat relative to its industry average of 12.14% during the same period. While the impressive ratio tells us that MTCH has made significant profits from little equity capital, ROE doesn’t tell us if MTCH has borrowed debt to make this happen. In this article, we’ll closely examine some factors like financial leverage to evaluate the sustainability of MTCH’s ROE. Check out our latest analysis for Match Group
What you must know about ROE
Firstly, Return on Equity, or ROE, is simply the percentage of last years’ earning against the book value of shareholders’ equity. It essentially shows how much the company can generate in earnings given the amount of equity it has raised. 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 Match Group, which is 10.72%. Given a positive discrepancy of 77.54% between return and cost, this indicates that Match Group pays less for its capital than what it generates in return, which is a sign of capital efficiency. 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. The other component, asset turnover, illustrates how much revenue Match Group can make from its 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 Match Group’s historic debt-to-equity ratio. At 237.50%, Match Group’s debt-to-equity ratio appears relatively high and indicates the above-average ROE is generated by significant leverage levels.
What this means for you:
Are you a shareholder? MTCH’s ROE is impressive relative to the industry average and also covers its cost of equity. However, its high debt level appears to be the driver of a strong ROE and is something you should be mindful of before adding more of MTCH to your portfolio. If you’re looking for new ideas for high-returning stocks, you should take a look at our free platform to see the list of stocks with Return on Equity over 20%.