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Did TRI Pointe Group Inc (NYSE:TPH) Create Value For Investors Over The Past Year?

This article is intended for those of you who are at the beginning of your investing journey and want to start learning about core concepts of fundamental analysis on practical examples from today’s market.

TRI Pointe Group Inc’s (NYSE:TPH) most recent return on equity was a substandard 12.5% relative to its industry performance of 12.6% over the past year. TPH’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 TPH’s performance. Today I will look at how components such as financial leverage can influence ROE which may impact the sustainability of TPH’s returns.

View our latest analysis for TRI Pointe Group

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

Return on Equity (ROE) is a measure of TRI Pointe Group’s profit relative to its shareholders’ equity. An ROE of 12.5% implies $0.12 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 TRI Pointe Group, which is 12.3%. TRI Pointe Group’s ROE exceeds its cost by 0.2%, which is a big tick. Some of its peers with higher ROE may face a cost which exceeds returns, which is unsustainable and far less desirable than TRI Pointe Group’s case of positive discrepancy. 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

NYSE:TPH Last Perf September 28th 18
NYSE:TPH Last Perf September 28th 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 shows how much revenue TRI Pointe Group can generate with its current 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 financial leverage can artificially inflate ROE, we need to look at how much debt TRI Pointe Group currently has. The debt-to-equity ratio currently stands at a sensible 71.5%, meaning the ROE is a result of its capacity to produce profit growth without a huge debt burden.

NYSE:TPH Historical Debt September 28th 18
NYSE:TPH Historical Debt September 28th 18

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. Although TRI Pointe Group’s ROE is underwhelming relative to the industry average, its returns are high enough to cover the cost of equity. Also, 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 TRI Pointe Group, I’ve compiled three relevant 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 TRI Pointe Group 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 TRI Pointe Group is currently mispriced by the market.

  3. Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of TRI Pointe Group? 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.