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What is Behind Dick’s Sporting Goods Inc’s (NYSE:DKS) Superior ROE?

This analysis is intended to introduce important early concepts to people who are starting to invest and want to learn about Return on Equity using a real-life example.

Dick’s Sporting Goods Inc (NYSE:DKS) outperformed the Specialty Stores industry on the basis of its ROE – producing a higher 17.2% relative to the peer average of 13.0% over the past 12 months. Superficially, this looks great since we know that DKS has generated big profits with little equity capital; however, ROE doesn’t tell us how much DKS has borrowed in debt. In this article, we’ll closely examine some factors like financial leverage to evaluate the sustainability of DKS’s ROE.

View our latest analysis for Dick’s Sporting Goods

Peeling the layers of ROE – trisecting a company’s profitability

Return on Equity (ROE) is a measure of Dick’s Sporting Goods’s profit relative to its shareholders’ equity. It essentially shows how much the company can generate in earnings given the amount of equity it has raised. 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

Returns are usually compared to costs to measure the efficiency of capital. Dick’s Sporting Goods’s cost of equity is 9.3%. This means Dick’s Sporting Goods returns enough to cover its own cost of equity, with a buffer of 7.9%. This sustainable practice implies that the company pays less for its capital than what it generates in return. ROE can be broken down into three different 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

NYSE:DKS Last Perf September 2nd 18
NYSE:DKS Last Perf September 2nd 18

The first component is profit margin, which measures how much of sales is retained after the company pays for all its expenses. Asset turnover reveals how much revenue can be generated from Dick’s Sporting Goods’s 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 Dick’s Sporting Goods currently has. At 8.9%, Dick’s Sporting Goods’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.

NYSE:DKS Historical Debt September 2nd 18
NYSE:DKS Historical Debt September 2nd 18

Next Steps:

ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. Dick’s Sporting Goods’s above-industry ROE is encouraging, and is also in excess of 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. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.

For Dick’s Sporting Goods, there are three fundamental factors you should look at:

  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 Dick’s Sporting Goods 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 Dick’s Sporting Goods is currently mispriced by the market.

  3. Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Dick’s Sporting Goods? 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.