Stadlauer Malzfabrik Aktiengesellschaft (WBAG:STM) delivered a less impressive 3.63% ROE over the past year, compared to the 14.13% return generated by its industry. An investor may attribute an inferior ROE to a relatively inefficient performance, and whilst this can often be the case, knowing the nuts and bolts of the ROE calculation may change that perspective and give you a deeper insight into STM’s past performance. Today I will look at how components such as financial leverage can influence ROE which may impact the sustainability of STM’s returns. View our latest analysis for Stadlauer Malzfabrik
Peeling the layers of ROE – trisecting a company’s profitability
Return on Equity (ROE) weighs Stadlauer Malzfabrik’s profit against the level of its shareholders’ equity. For example, if the company invests €1 in the form of equity, it will generate €0.04 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 Stadlauer Malzfabrik’s equity capital deployed. Its cost of equity is 8.18%. Given a discrepancy of -4.54% between return and cost, this indicated that Stadlauer Malzfabrik may be paying more for its capital than what it’s generating 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
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 Stadlauer Malzfabrik’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 Stadlauer Malzfabrik’s debt-to-equity level. Currently, Stadlauer Malzfabrik has no debt which means its returns are driven purely by equity capital. This could explain why Stadlauer Malzfabrik’s’ ROE is lower than its industry peers, most of which may have some degree of debt in its business.