Brouwerij Handelsmaatschappij NV (ENXTBR:COBH) generated a below-average return on equity of 6.22% in the past 12 months, while its industry returned 11.40%. Though COBH’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 COBH’s below-average returns. I will take you through how metrics such as financial leverage impact ROE which may affect the overall sustainability of COBH’s returns. See our latest analysis for Brouwerij Handelsmaatschappij
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. 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 measured against cost of equity in order to determine the efficiency of Brouwerij Handelsmaatschappij’s equity capital deployed. Its cost of equity is 8.19%. Since Brouwerij Handelsmaatschappij’s return does not cover its cost, with a difference of -1.97%, this means its current use of equity is not efficient and not sustainable. Very simply, Brouwerij Handelsmaatschappij pays more for its capital than what it generates in return. ROE can be dissected into three distinct 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. Asset turnover reveals how much revenue can be generated from Brouwerij Handelsmaatschappij’s 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 Brouwerij Handelsmaatschappij’s historic debt-to-equity ratio. The debt-to-equity ratio currently stands at a low 1.74%, meaning Brouwerij Handelsmaatschappij still has headroom to borrow debt to increase profits.
Next Steps:
While ROE is a relatively simple calculation, it can be broken down into different ratios, each telling a different story about the strengths and weaknesses of a company. Brouwerij Handelsmaatschappij exhibits a weak ROE against its peers, as well as insufficient levels to cover its own cost of equity this year. However, ROE is not likely to be inflated by excessive debt funding, giving shareholders more conviction in the sustainability of returns, which has headroom to increase further. Although ROE can be a useful metric, it is only a small part of diligent research.