With an ROE of 13.23%, United States Lime & Minerals Inc (NASDAQ:USLM) outpaced its own industry which delivered a less exciting 8.76% over the past year. Superficially, this looks great since we know that USLM has generated big profits with little equity capital; however, ROE doesn’t tell us how much USLM has borrowed in debt. We’ll take a closer look today at factors like financial leverage to determine whether USLM’s ROE is actually sustainable. Check out our latest analysis for United States Lime & Minerals

Peeling the layers of ROE – trisecting a company’s profitability

Return on Equity (ROE) weighs United States Lime & Minerals’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. 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 United States Lime & Minerals’s equity capital deployed. Its cost of equity is 8.49%. Given a positive discrepancy of 4.73% between return and cost, this indicates that United States Lime & Minerals pays less for its capital than what it generates in return, which is a sign of capital efficiency. ROE can be dissected into three distinct 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

The first component is profit margin, which measures how much of sales is retained after the company pays for all its expenses. Asset turnover reveals how much revenue can be generated from United States Lime & Minerals’s 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 United States Lime & Minerals’s debt-to-equity level. Currently, United States Lime & Minerals has no debt which means its returns are driven purely by equity capital. Therefore, the level of financial leverage has no impact on ROE, and the ratio is a representative measure of the efficiency of all its capital employed firm-wide.