How Did AC Spólka Akcyjna’s (WSE:ACG) 37.9% ROE Fare Against The Industry?

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.

AC Spólka Akcyjna (WSE:ACG) outperformed the Auto Parts and Equipment industry on the basis of its ROE – producing a higher 37.9% relative to the peer average of 14.4% over the past 12 months. On the surface, this looks fantastic since we know that ACG has made large profits from little equity capital; however, ROE doesn’t tell us if management have borrowed heavily to make this happen. In this article, we’ll closely examine some factors like financial leverage to evaluate the sustainability of ACG’s ROE.

View our latest analysis for AC Spólka Akcyjna

What you must know about ROE

Firstly, Return on Equity, or ROE, is simply the percentage of last years’ earning against the book value of shareholders’ equity. It essentially shows how much the company can generate in earnings given the amount of equity it has raised. 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 AC Spólka Akcyjna’s equity capital deployed. Its cost of equity is 9.6%. This means AC Spólka Akcyjna returns enough to cover its own cost of equity, with a buffer of 28.3%. This sustainable practice implies that the company pays less for its capital than what it generates in return. ROE can be split up into three useful 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

Basically, profit margin measures how much of revenue trickles down into earnings which illustrates how efficient the business is with its cost management. Asset turnover shows how much revenue AC Spólka Akcyjna can generate with its current 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 AC Spólka Akcyjna currently has. Currently AC Spólka Akcyjna has virtually no debt, which means its returns are predominantly driven by equity capital. Therefore, the level of financial leverage has no impact on ROE, and the ratio is a representative measure of the efficiency of all its capital employed firm-wide.