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What You Must Know About IAC/InterActiveCorp’s (NASDAQ:IAC) ROE

I am writing today to help inform people who are new to the stock market and want to begin learning the link between company’s fundamentals and stock market performance.

IAC/InterActiveCorp (NASDAQ:IAC) outperformed the Internet Software and Services industry on the basis of its ROE – producing a higher 18.6% relative to the peer average of 11.6% over the past 12 months. On the surface, this looks fantastic since we know that IAC has made large profits from little equity capital; however, ROE doesn’t tell us if management have borrowed heavily to make this happen. Today, we’ll take a closer look at some factors like financial leverage to see how sustainable IAC’s ROE is.

See our latest analysis for IAC/InterActiveCorp

Breaking down Return on Equity

Return on Equity (ROE) weighs IAC/InterActiveCorp’s profit against the level of its shareholders’ equity. An ROE of 18.6% implies $0.19 returned on every $1 invested. While a higher ROE is preferred in most cases, there are several other factors we should consider before drawing any conclusions.

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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 IAC/InterActiveCorp, which is 12.6%. Since IAC/InterActiveCorp’s return covers its cost in excess of 6.0%, its use of equity capital is efficient and likely to be sustainable. Simply put, IAC/InterActiveCorp pays less 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

NasdaqGS:IAC Last Perf August 31st 18
NasdaqGS:IAC Last Perf August 31st 18

Essentially, profit margin shows how much money the company makes after paying for all its expenses. Asset turnover shows how much revenue IAC/InterActiveCorp can generate with its current asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. Since financial leverage can artificially inflate ROE, we need to look at how much debt IAC/InterActiveCorp currently has. The debt-to-equity ratio currently stands at a sensible 60.3%, meaning the above-average ROE is due to its capacity to produce profit growth without a huge debt burden.

NasdaqGS:IAC Historical Debt August 31st 18
NasdaqGS:IAC Historical Debt August 31st 18

Next Steps:

ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. IAC/InterActiveCorp’s ROE is impressive relative to the industry average and also covers 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 IAC/InterActiveCorp, I’ve compiled three key factors you should further research:

  1. 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.

  2. Valuation: What is IAC/InterActiveCorp 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 IAC/InterActiveCorp is currently mispriced by the market.

  3. Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of IAC/InterActiveCorp? 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.