Yahoo Finance What You Must Know About MSL Solutions Limited’s (ASX:MPW) 0.2% ROE
The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to begin learning the link between company’s fundamentals and stock market performance.
MSL Solutions Limited (ASX:MPW) generated a below-average return on equity of 0.2% in the past 12 months, while its industry returned 6.9%. Though MPW’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 MPW’s below-average returns. I will take you through how metrics such as financial leverage impact ROE which may affect the overall sustainability of MPW’s returns.
Check out our latest analysis for MSL Solutions
What you must know about ROE
Return on Equity (ROE) is a measure of MSL Solutions’s profit relative to its shareholders’ equity. For example, if the company invests A$1 in the form of equity, it will generate A$0.0021 in earnings from this. Generally speaking, a higher ROE is preferred; however, there are other factors we must also consider before making any conclusions.
Return on Equity = Net Profit ÷ Shareholders Equity
ROE is assessed against cost of equity, which is measured using the Capital Asset Pricing Model (CAPM) – but let’s not dive into the details of that today. For now, let’s just look at the cost of equity number for MSL Solutions, which is 8.6%. Given a discrepancy of -8.3% between return and cost, this indicated that MSL Solutions may be paying more for its capital than what it’s generating 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. The other component, asset turnover, illustrates how much revenue MSL Solutions can make from its 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 MSL Solutions’s historic debt-to-equity ratio. Currently MSL Solutions has virtually no debt, which means its returns are predominantly driven by equity capital. This could explain why MSL Solutions’s’ ROE is lower than its industry peers, most of which may have some degree of debt in its business.
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. MSL Solutions’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 MSL Solutions’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 MSL Solutions, there are three essential factors you should further research:
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 MSL Solutions 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 MSL Solutions is currently mispriced by the market.
Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of MSL Solutions? 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.
