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With an ROE of 28.94%, Atresmedia Corporación de Medios de Comunicación SA. (BME:A3M) outpaced its own industry which delivered a less exciting 11.44% over the past year. On the surface, this looks fantastic since we know that A3M has made large profits from little equity capital; however, ROE doesn’t tell us if management have borrowed heavily to make this happen. In this article, we’ll closely examine some factors like financial leverage to evaluate the sustainability of A3M’s ROE. View our latest analysis for Atresmedia Corporación de Medios de Comunicación
Peeling the layers of ROE – trisecting a company’s profitability
Return on Equity (ROE) is a measure of Atresmedia Corporación de Medios de Comunicación’s profit relative to its shareholders’ equity. It essentially shows how much the company can generate in earnings given the amount of equity it has raised. 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
Returns are usually compared to costs to measure the efficiency of capital. Atresmedia Corporación de Medios de Comunicación’s cost of equity is 8.50%. This means Atresmedia Corporación de Medios de Comunicación returns enough to cover its own cost of equity, with a buffer of 20.44%. This sustainable practice implies that the company pays less 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 reveals how much revenue can be generated from Atresmedia Corporación de Medios de Comunicación’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 artificially increased through excessive borrowing, we should check Atresmedia Corporación de Medios de Comunicación’s historic debt-to-equity ratio. Currently the debt-to-equity ratio stands at a low 46.25%, which means its above-average ROE is driven by its ability to grow its profit without a significant debt burden.