With A Recent ROE Of 9.20%, Can Croma Security Solutions Group PLC (LON:CSSG) Catch Up To Its Industry?

Croma Security Solutions Group PLC’s (AIM:CSSG) most recent return on equity was a substandard 9.20% relative to its industry performance of 13.69% over the past year. CSSG’s results could indicate a relatively inefficient operation to its peers, and while this may be the case, it is important to understand what ROE is made up of and how it should be interpreted. Knowing these components could change your view on CSSG’s performance. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of CSSG’s returns. Let me show you what I mean by this. View our latest analysis for Croma Security Solutions Group

What you must know about ROE

Return on Equity (ROE) weighs Croma Security Solutions Group’s profit against the level of its shareholders’ equity. An ROE of 9.20% implies £0.09 returned on every £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

Returns are usually compared to costs to measure the efficiency of capital. Croma Security Solutions Group’s cost of equity is 8.30%. While Croma Security Solutions Group’s peers may have higher ROE, it may also incur higher cost of equity. An undesirable and unsustainable practice would be if returns exceeded cost. However, this is not the case for Croma Security Solutions Group which is encouraging. 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

AIM:CSSG Last Perf Mar 4th 18
AIM:CSSG Last Perf Mar 4th 18

Basically, profit margin measures how much of revenue trickles down into earnings which illustrates how efficient the business is with its cost management. Asset turnover shows how much revenue Croma Security Solutions Group can generate with its current 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 inflated by excessive debt, we need to examine Croma Security Solutions Group’s debt-to-equity level. Currently, Croma Security Solutions Group has no debt which means its returns are driven purely by equity capital. This could explain why Croma Security Solutions Group’s’ ROE is lower than its industry peers, most of which may have some degree of debt in its business.