War and Peace Media group (MISX:MGVM) delivered a less impressive 7.09% ROE over the past year, compared to the 12.52% return generated by its industry. 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 MGVM’s past performance. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of MGVM’s returns. Let me show you what I mean by this. See our latest analysis for War and Peace Media group
Breaking down ROE — the mother of all ratios
Return on Equity (ROE) weighs War and Peace Media group’s profit against the level of its 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
Returns are usually compared to costs to measure the efficiency of capital. War and Peace Media group’s cost of equity is 13.69%. This means War and Peace Media group’s returns actually do not cover its own cost of equity, with a discrepancy of -6.61%. This isn’t sustainable as it implies, very simply, that the company 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 War and Peace Media 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 inflated by excessive debt, we need to examine War and Peace Media group’s debt-to-equity level. Currently, War and Peace Media group has no debt which means its returns are driven purely by equity capital. This could explain why War and Peace Media group’s’ ROE is lower than its industry peers, most of which may have some degree of debt in its business.