Wins Finance Holdings Inc (NASDAQ:WINS) delivered a less impressive 8.11% ROE over the past year, compared to the 12.81% 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 WINS’s past performance. Today I will look at how components such as financial leverage can influence ROE which may impact the sustainability of WINS’s returns. View our latest analysis for Wins Finance Holdings
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. 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 Wins Finance Holdings’s equity capital deployed. Its cost of equity is 8.74%. Since Wins Finance Holdings’s return does not cover its cost, with a difference of -0.63%, this means its current use of equity is not efficient and not sustainable. Very simply, Wins Finance Holdings pays more for its capital than what it generates in return. 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
Basically, profit margin measures how much of revenue trickles down into earnings which illustrates how efficient the business is with its cost management. The other component, asset turnover, illustrates how much revenue Wins Finance Holdings can make from its 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 financial leverage can artificially inflate ROE, we need to look at how much debt Wins Finance Holdings currently has. Currently the debt-to-equity ratio stands at a low 14.66%, which means Wins Finance Holdings still has headroom to take on more leverage in order to increase profits.