Why Altaba Inc (AABA) May Not Be As Efficient As Its Industry
Renee Allred
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Altaba Inc ( NASDAQ:AABA ) generated a below-average return on equity of 4.73% in the past 12 months, while its industry returned 10.09%. Though AABA's recent performance is underwhelming, it is useful to understand what ROE is made up of and how it should be interpreted. Knowing these components can change your views on AABA's below-average returns. I will take you through how metrics such as financial leverage impact ROE which may affect the overall sustainability of AABA's returns. View our latest analysis for Altaba
What you must know about ROE
Return on Equity (ROE) is a measure of AABA’s profit relative to its shareholders’ equity. For example, if AABA invests $1 in the form of equity, it will generate $0.05 in earnings from this. 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
Returns are usually compared to costs to measure the efficiency of capital. AABA’s cost of equity is 11.99%. Since AABA’s return does not cover its cost, with a difference of -7.25%, this means its current use of equity is not efficient and not sustainable. Very simply, AABA pays more 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:
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
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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 AABA 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 AABA’s capital structure is. Since ROE can be artificially increased through excessive borrowing, we should check AABA’s historic debt-to-equity ratio. Currently the debt-to-equity ratio stands at a low 2.76%, which means AABA still has headroom to take on more leverage in order to increase profits.