CCL Industries Inc (TSX:CCL.B) generated a below-average return on equity of 21.59% in the past 12 months, while its industry returned 21.59%. Though CCL.B’s recent performance is underwhelming, it is useful to understand what ROE is made up of and how it should be interpreted. Knowing these components can change your views on CCL.B’s below-average returns. I will take you through how metrics such as financial leverage impact ROE which may affect the overall sustainability of CCL.B’s returns. See our latest analysis for CCL.B
Breaking down Return on Equity
Return on Equity (ROE) is a measure of CCL.B’s profit relative to its shareholders’ equity. For example, if CCL.B invests CA$1 in the form of equity, it will generate CA$0.22 in earnings from this. 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. CCL.B’s cost of equity is 8.43%. 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 CCL.B is with its cost management. Asset turnover reveals how much revenue can be generated from CCL.B’s asset base. And finally, financial leverage is simply how much of assets are funded by equity, which exhibits how sustainable CCL.B’s capital structure is. Since ROE can be artificially increased through excessive borrowing, we should check CCL.B’s historic debt-to-equity ratio. The debt-to-equity ratio currently stands at a balanced 124.15%, meaning the ROE is a result of its capacity to produce profit growth without a huge debt burden.
What this means for you:
Are you a shareholder? Although CCL.B’s ROE is underwhelming relative to the industry average, its returns are high enough to cover the cost of equity, which is encouraging. Since its high ROE is not likely driven by high debt, it might be a good time to top up on your current holdings if your fundamental research reaffirms this analysis. 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%.