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Thermador Groupe SA (ENXTPA:THEP) outperformed the Trading Companies and Distributors industry on the basis of its ROE – producing a higher 13.84% relative to the peer average of 10.74% over the past 12 months. Superficially, this looks great since we know that THEP has generated big profits with little equity capital; however, ROE doesn’t tell us how much THEP has borrowed in debt. Today, we’ll take a closer look at some factors like financial leverage to see how sustainable THEP’s ROE is. Check out our latest analysis for Thermador Groupe
Breaking down ROE — the mother of all ratios
Firstly, Return on Equity, or ROE, is simply the percentage of last years’ earning against the book value of shareholders’ equity. For example, if the company invests €1 in the form of equity, it will generate €0.14 in earnings from this. 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
ROE is measured against cost of equity in order to determine the efficiency of Thermador Groupe’s equity capital deployed. Its cost of equity is 8.18%. Given a positive discrepancy of 5.65% between return and cost, this indicates that Thermador Groupe pays less for its capital than what it generates in return, which is a sign of capital efficiency. 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 shows how much revenue Thermador Groupe can generate with its current 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 Thermador Groupe’s debt-to-equity level. Currently the debt-to-equity ratio stands at a low 17.11%, which means its above-average ROE is driven by its ability to grow its profit without a significant debt burden.
Next Steps:
ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. Thermador Groupe’s ROE is impressive relative to the industry average and also covers its cost of equity. ROE is not likely to be inflated by excessive debt funding, giving shareholders more conviction in the sustainability of high returns. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.