Urban One Inc (NASDAQ:UONE.K) outperformed the Broadcasting industry on the basis of its ROE – producing a higher 210.47% relative to the peer average of 14.06% over the past 12 months. On the surface, this looks fantastic since we know that UONE.K has made large profits from little equity capital; however, ROE doesn’t tell us if management have borrowed heavily to make this happen. In this article, we’ll closely examine some factors like financial leverage to evaluate the sustainability of UONE.K’s ROE. View our latest analysis for Urban One
Peeling the layers of ROE – trisecting a company’s profitability
Return on Equity (ROE) is a measure of Urban One’s profit relative to 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. Urban One’s cost of equity is 17.53%. Since Urban One’s return covers its cost in excess of 192.94%, its use of equity capital is efficient and likely to be sustainable. Simply put, Urban One pays less for its capital than what it generates in return. ROE can be broken down into three different 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. The other component, asset turnover, illustrates how much revenue Urban One can make from its asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. Since ROE can be artificially increased through excessive borrowing, we should check Urban One’s historic debt-to-equity ratio. The debt-to-equity ratio currently stands at over 2.5 times, meaning the above-average ratio is a result of a large amount of debt.
Next Steps:
While ROE is a relatively simple calculation, it can be broken down into different ratios, each telling a different story about the strengths and weaknesses of a company. Urban One’s above-industry ROE is encouraging, and is also in excess of its cost of equity. Its high debt level means its strong ROE may be driven by debt funding which raises concerns over the sustainability of Urban One’s returns. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.