Funko Inc (NASDAQ:FNKO) generated a below-average return on equity of 11.66% in the past 12 months, while its industry returned 12.67%. 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 FNKO’s past performance. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of FNKO’s returns. Let me show you what I mean by this. Check out our latest analysis for Funko
Breaking down Return on Equity
Return on Equity (ROE) is a measure of FNKO’s profit relative to its shareholders’ equity. For example, if FNKO invests $1 in the form of equity, it will generate $0.12 in earnings from this. 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. FNKO’s cost of equity is 13.10%. This means FNKO’s returns actually do not cover its own cost of equity, with a discrepancy of -1.44%. This isn’t sustainable as it implies, very simply, that the company pays more for its capital than what it generates in return. ROE can be split up into three useful 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
The first component is profit margin, which measures how much of sales is retained after the company pays for all its expenses. The other component, asset turnover, illustrates how much revenue FNKO can make from its asset base. And finally, financial leverage is simply how much of assets are funded by equity, which exhibits how sustainable FNKO’s capital structure is. Since ROE can be inflated by excessive debt, we need to examine FNKO’s debt-to-equity level. The debt-to-equity ratio currently stands at a high 218.77%, meaning the below-average ratio is already being driven by a large amount of debt.
What this means for you:
Are you a shareholder? FNKO’s ROE is underwhelming relative to the industry average, and its returns were also not strong enough to cover its own cost of equity. Additionally, its high debt level appears to be a key driver of its ROE and is something you should be mindful of before adding more of FNKO to your portfolio. 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%.