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Financière de Tubize SA (ENXTBR:TUB) outperformed the Pharmaceuticals industry on the basis of its ROE – producing a higher 13.52% relative to the peer average of 11.38% over the past 12 months. Superficially, this looks great since we know that TUB has generated big profits with little equity capital; however, ROE doesn’t tell us how much TUB has borrowed in debt. In this article, we’ll closely examine some factors like financial leverage to evaluate the sustainability of TUB’s ROE. View our latest analysis for Financière de Tubize
Peeling the layers of ROE – trisecting a company’s profitability
Return on Equity (ROE) weighs Financière de Tubize’s profit against the level of its shareholders’ equity. An ROE of 13.52% implies €0.14 returned on every €1 invested. 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. Financière de Tubize’s cost of equity is 8.19%. Since Financière de Tubize’s return covers its cost in excess of 5.33%, its use of equity capital is efficient and likely to be sustainable. Simply put, Financière de Tubize 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 Financière de Tubize’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 inflated by excessive debt, we need to examine Financière de Tubize’s debt-to-equity level. The debt-to-equity ratio currently stands at a low 9.22%, meaning the above-average ROE is due to its capacity to produce profit growth without a huge debt burden.
Next Steps:
ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. Financière de Tubize’s above-industry ROE is encouraging, and is also in excess of its cost of equity. Its high ROE is not likely to be driven by high debt. Therefore, investors may have more confidence in the sustainability of this level of returns going forward. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.