Banco Latinoamericano de Comercio Exterior SA (NYSE:BLX) generated a below-average return on equity of 7.32% in the past 12 months, while its industry returned 8.93%. Though BLX’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 BLX’s below-average returns. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of BLX’s returns. Let me show you what I mean by this. Check out our latest analysis for Banco Latinoamericano de Comercio Exterior
Peeling the layers of ROE – trisecting a company’s profitability
Return on Equity (ROE) is a measure of BLX’s profit relative to its shareholders’ equity. An ROE of 7.32% implies $0.07 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
Returns are usually compared to costs to measure the efficiency of capital. BLX’s cost of equity is 9.87%. Since BLX’s return does not cover its cost, with a difference of -2.55%, this means its current use of equity is not efficient and not sustainable. Very simply, BLX 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:
ROE = profit margin × asset turnover × financial leverage
ROE = (annual net profit ÷ sales) × (sales ÷ assets) × (assets ÷ shareholders’ equity)
ROE = annual net profit ÷ shareholders’ equityfigure data-type="image" itemscope="" itemprop="associatedMedia image" itemtype="https://schema.org/ImageObject" data-reactid="37"">
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 BLX 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 BLX’s capital structure is. Since ROE can be artificially increased through excessive borrowing, we should check BLX’s historic debt-to-equity ratio. The debt-to-equity ratio currently stands at a high 205.53%, meaning the below-average ratio is already being driven by a large amount of debt.figure data-type="image" itemscope="" itemprop="associatedMedia image" itemtype="https://schema.org/ImageObject" data-reactid="50"">
What this means for you:
Are you a shareholder? BLX exhibits a weak ROE against its peers, as well as insufficient levels to cover its own cost of equity this year. Additionally, its high debt level appears to be a key driver of its ROE and is something you should be mindful of before adding more of BLX to your portfolio. If you’re looking for new ideas for high-returning stocks, you should take a look at our free platform to see the list of stocks with Return on Equity over 20%.
Are you a potential investor? If BLX has been on your watch list for a while, making an investment decision based on ROE alone is unwise. I recommend you do additional fundamental analysis by looking through our most recent infographic report on Banco Latinoamericano de Comercio Exterior to help you make a more informed investment decision.
To help readers see pass 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.
Source : https://finance.yahoo.com/news/did-banco-latinoamericano-comercio-exterior-221808720.html1540