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 Appliance Recycling Centers of America Inc (NASDAQ:ARCI).
With an ROE of 20.57%, Appliance Recycling Centers of America Inc (NASDAQ:ARCI) outpaced its own industry which delivered a less exciting 12.96% over the past year. While the impressive ratio tells us that ARCI has made significant profits from little equity capital, ROE doesn’t tell us if ARCI has borrowed debt to make this happen. We’ll take a closer look today at factors like financial leverage to determine whether ARCI’s ROE is actually sustainable. View out our latest analysis for Appliance Recycling Centers of America
Peeling the layers of ROE – trisecting a company’s profitability
Return on Equity (ROE) is a measure of Appliance Recycling Centers of America’s profit relative to its shareholders’ equity. An ROE of 20.57% implies $0.21 returned on every $1 invested. 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 measured against cost of equity in order to determine the efficiency of Appliance Recycling Centers of America’s equity capital deployed. Its cost of equity is 13.76%. Since Appliance Recycling Centers of America’s return covers its cost in excess of 6.81%, its use of equity capital is efficient and likely to be sustainable. Simply put, Appliance Recycling Centers of America 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:
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 Appliance Recycling Centers of America 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 inflated by excessive debt, we need to examine Appliance Recycling Centers of America’s debt-to-equity level. At 22.40%, Appliance Recycling Centers of America’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.
ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. Appliance Recycling Centers of America’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 Appliance Recycling Centers of America, I’ve compiled three key 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 Appliance Recycling Centers of America 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 Appliance Recycling Centers of America is currently mispriced by the market.
- Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Appliance Recycling Centers of America? 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.