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Four Corners Property Trust Inc (NYSE:FCPT) outperformed the Specialized REITs industry on the basis of its ROE – producing a higher 13.76% relative to the peer average of 7.62% over the past 12 months. While the impressive ratio tells us that FCPT has made significant profits from little equity capital, ROE doesn’t tell us if FCPT has borrowed debt to make this happen. In this article, we’ll closely examine some factors like financial leverage to evaluate the sustainability of FCPT’s ROE. Check out our latest analysis for Four Corners Property Trust
Breaking down ROE — the mother of all ratios
Return on Equity (ROE) weighs Four Corners Property Trust’s profit against the level of 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. Four Corners Property Trust’s cost of equity is 8.49%. This means Four Corners Property Trust returns enough to cover its own cost of equity, with a buffer of 5.26%. This sustainable practice implies that the company pays less 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. Asset turnover reveals how much revenue can be generated from Four Corners Property Trust’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 artificially increased through excessive borrowing, we should check Four Corners Property Trust’s historic debt-to-equity ratio. The debt-to-equity ratio currently stands at a balanced 97.73%, meaning the above-average ROE is due to its capacity to produce profit growth without a huge debt burden.
Next Steps:
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. Four Corners Property Trust exhibits a strong ROE against its peers, as well as sufficient returns to cover its cost of equity. ROE is not likely to be inflated by excessive debt funding, giving shareholders more conviction in the sustainability of high returns. Although ROE can be a useful metric, it is only a small part of diligent research.