In This Article:
With an ROE of 9.45%, Precinct Properties New Zealand Limited (NZSE:PCT) outpaced its own industry which delivered a less exciting 8.75% over the past year. On the surface, this looks fantastic since we know that PCT has made large profits from little equity capital; however, ROE doesn’t tell us if management have borrowed heavily to make this happen. In this article, we’ll closely examine some factors like financial leverage to evaluate the sustainability of PCT’s ROE. View our latest analysis for Precinct Properties New Zealand
What you must know about ROE
Return on Equity (ROE) is a measure of Precinct Properties New Zealand’s profit relative to its shareholders’ equity. It essentially shows how much the company 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 measured against cost of equity in order to determine the efficiency of Precinct Properties New Zealand’s equity capital deployed. Its cost of equity is 8.55%. Since Precinct Properties New Zealand’s return covers its cost in excess of 0.90%, its use of equity capital is efficient and likely to be sustainable. Simply put, Precinct Properties New Zealand pays less 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
Essentially, profit margin shows how much money the company makes after paying for all its expenses. Asset turnover reveals how much revenue can be generated from Precinct Properties New Zealand’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 Precinct Properties New Zealand’s historic debt-to-equity ratio. The debt-to-equity ratio currently stands at a low 42.69%, meaning the above-average ROE is due to its capacity to produce profit growth without a huge debt burden.
Next Steps:
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. Precinct Properties New Zealand exhibits a strong ROE against its peers, as well as sufficient returns to cover 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.