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SergeFerrari Group SA (ENXTPA:SEFER) generated a below-average return on equity of 2.69% in the past 12 months, while its industry returned 13.22%. Though SEFER’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 SEFER’s below-average returns. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of SEFER’s returns. Let me show you what I mean by this. See our latest analysis for SergeFerrari Group
Breaking down Return on Equity
Return on Equity (ROE) weighs SergeFerrari Group’s profit against the level of its shareholders’ equity. An ROE of 2.69% implies €0.03 returned on every €1 invested. 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. SergeFerrari Group’s cost of equity is 8.39%. Given a discrepancy of -5.70% between return and cost, this indicated that SergeFerrari Group may be paying more for its capital than what it’s generating 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
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 SergeFerrari Group’s 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 SergeFerrari Group’s debt-to-equity level. The debt-to-equity ratio currently stands at a low 24.83%, meaning SergeFerrari Group still has headroom to borrow debt to increase profits.
Next Steps:
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. SergeFerrari Group exhibits a weak ROE against its peers, as well as insufficient levels to cover its own cost of equity this year. Although, its appropriate level of leverage means investors can be more confident in the sustainability of SergeFerrari Group’s return with a possible increase should the company decide to increase its debt levels. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.