1347 Property Insurance Holdings Inc’s (NASDAQ:PIH) most recent return on equity was a substandard 1.09% relative to its industry performance of 9.43% over the past year. An investor may attribute an inferior ROE to a relatively inefficient performance, and whilst this can often be the case, knowing the nuts and bolts of the ROE calculation may change that perspective and give you a deeper insight into PIH’s past performance. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of PIH’s returns. Let me show you what I mean by this. View our latest analysis for 1347 Property Insurance Holdings

What you must know about ROE

Return on Equity (ROE) is a measure of 1347 Property Insurance Holdings’s profit relative to its shareholders’ equity. For example, if the company invests $1 in the form of equity, it will generate $0.01 in earnings from this. 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

Returns are usually compared to costs to measure the efficiency of capital. 1347 Property Insurance Holdings’s cost of equity is 8.49%. Since 1347 Property Insurance Holdings’s return does not cover its cost, with a difference of -7.41%, this means its current use of equity is not efficient and not sustainable. Very simply, 1347 Property Insurance Holdings pays more 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

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 1347 Property Insurance Holdings 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 1347 Property Insurance Holdings’s historic debt-to-equity ratio. The debt-to-equity ratio currently stands at a low 6.02%, meaning 1347 Property Insurance Holdings still has headroom to borrow debt to increase profits.