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OPUS Group Limited (ASX:OPG) outperformed the Commercial Printing industry on the basis of its ROE – producing a higher 15.81% relative to the peer average of 9.08% over the past 12 months. Superficially, this looks great since we know that OPG has generated big profits with little equity capital; however, ROE doesn’t tell us how much OPG has borrowed in debt. We’ll take a closer look today at factors like financial leverage to determine whether OPG’s ROE is actually sustainable. View our latest analysis for OPUS Group
Peeling the layers of ROE – trisecting a company’s profitability
Return on Equity (ROE) is a measure of OPUS Group’s profit relative to its shareholders’ equity. An ROE of 15.81% implies A$0.16 returned on every A$1 invested. 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 measured against cost of equity in order to determine the efficiency of OPUS Group’s equity capital deployed. Its cost of equity is 8.55%. Given a positive discrepancy of 7.26% between return and cost, this indicates that OPUS Group pays less for its capital than what it generates in return, which is a sign of capital efficiency. 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
Essentially, profit margin shows how much money the company makes after paying for all its expenses. The other component, asset turnover, illustrates how much revenue OPUS Group can make from its asset base. Finally, financial leverage will be our main focus today. It shows how much of assets are funded by equity and can show how sustainable the company’s capital structure is. Since ROE can be artificially increased through excessive borrowing, we should check OPUS Group’s historic debt-to-equity ratio. Currently OPUS Group 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.
Next Steps:
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. OPUS Group’s ROE is impressive relative to the industry average and also covers its cost of equity. Its high ROE is not likely to be driven by high debt. Therefore, investors may have more confidence in the sustainability of this level of returns going forward. Although ROE can be a useful metric, it is only a small part of diligent research.