Yahoo Finance Did Southern Cross Media Group Limited (ASX:SXL) Create Value For Investors Over The Past Year?
This article is intended for those of you who are at the beginning of your investing journey and want to learn about Return on Equity using a real-life example.
Southern Cross Media Group Limited’s (ASX:SXL) most recent return on equity was a substandard 0.2% relative to its industry performance of 9.3% over the past year. SXL’s results could indicate a relatively inefficient operation to its peers, and while this may be the case, it is important to understand what ROE is made up of and how it should be interpreted. Knowing these components could change your view on SXL’s performance. I will take you through how metrics such as financial leverage impact ROE which may affect the overall sustainability of SXL’s returns.
Check out our latest analysis for Southern Cross Media Group
What you must know about ROE
Return on Equity (ROE) is a measure of Southern Cross Media Group’s profit relative to its shareholders’ equity. An ROE of 0.2% implies A$0.0024 returned on every A$1 invested. In most cases, a higher ROE is preferred; however, there are many other factors we must consider prior to making any investment decisions.
Return on Equity = Net Profit ÷ Shareholders Equity
Returns are usually compared to costs to measure the efficiency of capital. Southern Cross Media Group’s cost of equity is 8.6%. This means Southern Cross Media Group’s returns actually do not cover its own cost of equity, with a discrepancy of -8.3%. 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 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
The first component is profit margin, which measures how much of sales is retained after the company pays for all its expenses. Asset turnover shows how much revenue Southern Cross Media Group can generate with its current asset base. Finally, financial leverage will be our main focus today. It shows how much of assets are funded by equity and can show how sustainable the company’s capital structure is. Since financial leverage can artificially inflate ROE, we need to look at how much debt Southern Cross Media Group currently has. The debt-to-equity ratio currently stands at a sensible 60.4%, meaning the ROE is a result of 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. Southern Cross Media Group’s below-industry ROE is disappointing, furthermore, its returns were not even high enough to cover its own cost of equity. Although, its appropriate level of leverage means investors can be more confident in the sustainability of Southern Cross Media Group’s return with a possible increase should the company decide to increase its debt levels. Although ROE can be a useful metric, it is only a small part of diligent research.
For Southern Cross Media Group, I’ve put together three essential factors you should look at:
Financial Health: Does it have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
Valuation: What is Southern Cross Media Group worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether Southern Cross Media Group is currently mispriced by the market.
Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Southern Cross Media Group? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.
