Yahoo Finance Can Taylor Wimpey plc’s (LON:TW.) ROE Continue To Surpass The Industry Average?
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.
Taylor Wimpey plc (LON:TW.) delivered an ROE of 21.5% over the past 12 months, which is an impressive feat relative to its industry average of 16.2% during the same period. Superficially, this looks great since we know that TW. has generated big profits with little equity capital; however, ROE doesn’t tell us how much TW. has borrowed in debt. In this article, we’ll closely examine some factors like financial leverage to evaluate the sustainability of TW.’s ROE.
View our latest analysis for Taylor Wimpey
Breaking down ROE — the mother of all ratios
Return on Equity (ROE) weighs Taylor Wimpey’s profit against the level of its shareholders’ equity. An ROE of 21.5% implies £0.21 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 Taylor Wimpey, which is 8.3%. Since Taylor Wimpey’s return covers its cost in excess of 13.2%, its use of equity capital is efficient and likely to be sustainable. Simply put, Taylor Wimpey 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
Essentially, profit margin shows how much money the company makes after paying for all its expenses. The other component, asset turnover, illustrates how much revenue Taylor Wimpey can make from its 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 financial leverage can artificially inflate ROE, we need to look at how much debt Taylor Wimpey currently has. At 4.0%, Taylor Wimpey’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.
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. Taylor Wimpey’s ROE is impressive relative to the industry average and also covers its cost of equity. Its high ROE is not likely to be driven by high debt. Therefore, investors may have more confidence in the sustainability of this level of returns going forward. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.
For Taylor Wimpey, I’ve put together three important factors you should look at:
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 Taylor Wimpey 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 Taylor Wimpey is currently mispriced by the market.
Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Taylor Wimpey? 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.
