Stelios Kanakis Industrial and Commercial SA. Raw Materials for Confectionary, Bakery and Ice-Crea’s (ATSE:KANAK) most recent return on equity was a substandard 10.66% relative to its industry performance of 11.98% over the past year. KANAK’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 KANAK’s performance. Today I will look at how components such as financial leverage can influence ROE which may impact the sustainability of KANAK’s returns. See our latest analysis for Stelios Kanakis Industrial and Commercial Raw Materials for Confectionary Bakery and Ice-Crea
Breaking down Return on Equity
Return on Equity (ROE) weighs Stelios Kanakis Industrial and Commercial Raw Materials for Confectionary Bakery and Ice-Crea’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
Returns are usually compared to costs to measure the efficiency of capital. Stelios Kanakis Industrial and Commercial Raw Materials for Confectionary Bakery and Ice-Crea’s cost of equity is 8.85%. Stelios Kanakis Industrial and Commercial Raw Materials for Confectionary Bakery and Ice-Crea’s ROE exceeds its cost by 1.81%, which is a big tick. Some of its peers with higher ROE may face a cost which exceeds returns, which is unsustainable and far less desirable than Stelios Kanakis Industrial and Commercial Raw Materials for Confectionary Bakery and Ice-Crea’s case of positive discrepancy. 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 Stelios Kanakis Industrial and Commercial Raw Materials for Confectionary Bakery and Ice-Crea’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 artificially increased through excessive borrowing, we should check Stelios Kanakis Industrial and Commercial Raw Materials for Confectionary Bakery and Ice-Crea’s historic debt-to-equity ratio. Currently the debt-to-equity ratio stands at a low 7.71%, which means Stelios Kanakis Industrial and Commercial Raw Materials for Confectionary Bakery and Ice-Crea still has headroom to take on more leverage in order to increase profits.