Yahoo Finance How Did Reliance Steel & Aluminum Co’s (NYSE:RS) 14.19% ROE Fare Against The Industry?
I am writing today to help inform people who are new to the stock market and want to better understand how you can grow your money by investing in Reliance Steel & Aluminum Co (NYSE:RS).
Reliance Steel & Aluminum Co (NYSE:RS) outperformed the Steel industry on the basis of its ROE – producing a higher 14.19% relative to the peer average of 11.07% over the past 12 months. Superficially, this looks great since we know that RS has generated big profits with little equity capital; however, ROE doesn’t tell us how much RS has borrowed in debt. We’ll take a closer look today at factors like financial leverage to determine whether RS’s ROE is actually sustainable. View out our latest analysis for Reliance Steel & Aluminum
Breaking down ROE — the mother of all ratios
Return on Equity (ROE) is a measure of Reliance Steel & Aluminum’s profit relative to its shareholders’ equity. For example, if the company invests $1 in the form of equity, it will generate $0.14 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 Reliance Steel & Aluminum, which is 11.80%. Given a positive discrepancy of 2.39% between return and cost, this indicates that Reliance Steel & Aluminum pays less for its capital than what it generates in return, which is a sign of capital efficiency. 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 Reliance Steel & Aluminum 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 Reliance Steel & Aluminum’s historic debt-to-equity ratio. At 42.82%, Reliance Steel & Aluminum’s debt-to-equity ratio appears low and indicates the above-average ROE is generated from its capacity to increase profit without a large debt burden.
Next Steps:
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. Reliance Steel & Aluminum 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.
For Reliance Steel & Aluminum, there are three fundamental factors you should further examine:
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 Reliance Steel & Aluminum 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 Reliance Steel & Aluminum is currently mispriced by the market.
Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Reliance Steel & Aluminum? 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 pass 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.
