Yahoo Finance What You Must Know About Gentherm Incorporated’s (NASDAQ:THRM) Return on Equity
This analysis is intended to introduce important early concepts to people who are starting to invest and looking to gauge the potential return on investment in Gentherm Incorporated (NASDAQ:THRM).
Gentherm Incorporated (NASDAQ:THRM) generated a below-average return on equity of 3.73% in the past 12 months, while its industry returned 13.93%. THRM’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 THRM’s performance. I will take you through how metrics such as financial leverage impact ROE which may affect the overall sustainability of THRM’s returns. Check out our latest analysis for Gentherm
Peeling the layers of ROE – trisecting a company’s profitability
Return on Equity (ROE) is a measure of Gentherm’s profit relative to its shareholders’ equity. An ROE of 3.73% implies $0.037 returned on every $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
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 Gentherm, which is 9.94%. This means Gentherm’s returns actually do not cover its own cost of equity, with a discrepancy of -6.21%. 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
Basically, profit margin measures how much of revenue trickles down into earnings which illustrates how efficient the business is with its cost management. Asset turnover shows how much revenue Gentherm 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 ROE can be inflated by excessive debt, we need to examine Gentherm’s debt-to-equity level. Currently the debt-to-equity ratio stands at a low 17.89%, which means Gentherm still has headroom to take on more leverage in order to increase profits.
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. Gentherm’s ROE is underwhelming relative to the industry average, and its returns were also not strong enough to cover its own cost of equity. However, ROE is not likely to be inflated by excessive debt funding, giving shareholders more conviction in the sustainability of returns, which has headroom to increase further. Although ROE can be a useful metric, it is only a small part of diligent research.
For Gentherm, I’ve compiled 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 Gentherm 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 Gentherm is currently mispriced by the market.
Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Gentherm? 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.
