Pioneer Credit Limited (ASX:PNC) delivered an ROE of 13.87% over the past 12 months, which is an impressive feat relative to its industry average of 8.51% during the same period. While the impressive ratio tells us that PNC has made significant profits from little equity capital, ROE doesn’t tell us if PNC has borrowed debt to make this happen. We’ll take a closer look today at factors like financial leverage to determine whether PNC’s ROE is actually sustainable. View our latest analysis for Pioneer Credit
What you must know about ROE
Firstly, Return on Equity, or ROE, is simply the percentage of last years’ earning against the book value of shareholders’ equity. An ROE of 13.87% implies A$0.14 returned on every A$1 invested. Generally speaking, a higher ROE is preferred; however, there are other factors we must also consider before making any conclusions.
Return on Equity = Net Profit ÷ Shareholders Equity
Returns are usually compared to costs to measure the efficiency of capital. PNC’s cost of equity is 8.67%. Given a positive discrepancy of 5.20% between return and cost, this indicates that PNC pays less for its capital than what it generates in return, which is a sign of capital efficiency. 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 PNC’s asset base. And finally, financial leverage is simply how much of assets are funded by equity, which exhibits how sustainable PNC’s capital structure is. Since ROE can be inflated by excessive debt, we need to examine PNC’s debt-to-equity level. At 89.04%, PNC’s debt-to-equity ratio appears sensible and indicates the above-average ROE is generated from its capacity to increase profit without a large debt burden.
What this means for you:
Are you a shareholder? PNC’s ROE is impressive relative to the industry average and also covers its cost of equity. Since ROE is not inflated by excessive debt, it might be a good time to add more of PNC to your portfolio if your personal research is confirming what the ROE is telling you. If you’re looking for new ideas for high-returning stocks, you should take a look at our free platform to see the list of stocks with Return on Equity over 20%.