Esprinet Sp.A.’s (BIT:PRT) most recent return on equity was a substandard 7.45% relative to its industry performance of 11.01% over the past year. PRT’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 PRT’s performance. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of PRT’s returns. Let me show you what I mean by this. View our latest analysis for Esprinet
Breaking down ROE — the mother of all ratios
Return on Equity (ROE) weighs Esprinet’s profit against the level of its shareholders’ equity. For example, if the company invests €1 in the form of equity, it will generate €0.07 in earnings from this. While a higher ROE is preferred in most cases, there are several other factors we should consider before drawing any conclusions.
Return on Equity = Net Profit ÷ Shareholders Equity
ROE is measured against cost of equity in order to determine the efficiency of Esprinet’s equity capital deployed. Its cost of equity is 13.03%. Since Esprinet’s return does not cover its cost, with a difference of -5.58%, this means its current use of equity is not efficient and not sustainable. Very simply, Esprinet pays more for its capital than what it generates in return. 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
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 Esprinet 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 financial leverage can artificially inflate ROE, we need to look at how much debt Esprinet currently has. At 52.52%, Esprinet’s debt-to-equity ratio appears sensible and indicates its ROE is generated from its capacity to increase profit without a large debt burden.