The ultimate goal of investors is to earn a high return on our investments without taking undue risks.
Publicly traded companies are stewards of their investors’ capital.
The Board of directors and management of every publicly traded company have a responsibility to attempt to make a good return on the money that its owners have entrusted to the company.
This return is best measured by return on equity. This is their-bottom line after-tax profit divided by the owner’s equity on their balance sheet.
This short article explores the return on equity of the companies that I am tracking.
The table below ranks these companies from highest to lowest ROE and explains the three key factors that drove their achieved ROE.
Not surprisingly, some high ROE companies and industries rely on a high profit level as a percent of sales revenue. Apple Inc. is an example as is lululemon. But some companies achieve a high ROE despite a very low level of profit as a percent of sales revenue. Costco achieves an ROE of about 30% despite a very low profit on sales margin of about 3%. And some companies end up with a relatively low return on equity despite having a high profit on sales margin. RioCan Real Estate Investment Trust is an example. Its profits are very high in relation to its revenue but are relatively low in relation to its very large investment in assets and to the owner’s equity invested in those assets.
In “translating” profit over sales revenue into return on equity the other two key drivers are asset turnover (the number of dollars invested in assets for each dollar of sales revenue) and financial leverage (how many dollars of assets for each dollar of owner’s equity).
The following table ranks the ROE of a wide variety of companies and explains how the three drivers of ROE come together to result in the ROE in each case.
The formula used here is known as the “DuPont Formula”. It was developed back in the 1920s by Donaldson Brown, a finance executive at DuPont Corporation.
| Company | ROE | = | Profit/Sales | x | Sales/Assets | x | Assets/Equity | Explanation of ROE |
| Apple Inc. | 153% | = | 26% | x | 1.17 | x | 4.97 | The Trifecta! High profits on sales, asset light, and high leverage |
| Constellation Software Inc. | 69% | = | 14% | x | 0.82 | x | 5.99 | The Trifecta! High profits on sales, asset light, and high leverage |
| VISA Inc. | 50% | = | 57% | x | 0.38 | x | 2.29 | Massive profits over sales revenue explains this |
| lululemon athletica inc. | 44% | = | 17% | x | 1.44 | x | 1.77 | High profits on sales, relatively asset light with modest leverage |
| American Express Company | 33% | = | 15% | x | 0.23 | x | 9.74 | Massive equity leverage explains this despite low asset turnover |
| Costco | 32% | = | 3% | x | 3.74 | x | 3.12 | Very high asset turnover and leverage overcome the low profits on sales |
| Restaurant Brands International Inc. | 30% | = | 20% | x | 0.30 | x | 5.02 | High profits on sales and high equity leverage overcome low asset turnover |
| Canadian National Railway Company | 24% | = | 27% | x | 0.31 | x | 2.80 | Very high profits over sales are key here |
| Canadian Natural Resources | 22% | = | 24% | x | 0.48 | x | 1.92 | Very high profits over sales are key here |
| Alimentation Couche-Tard Inc. | 21% | = | 4% | x | 1.87 | x | 2.80 | High asset turnover and leverage overcome the low profits on sales |
| TFI International Inc. | 20% | = | 7% | x | 1.08 | x | 2.83 | Good profit over sales, good asset turnover and high equity leverage |
| Company | ROE | = | Profit/Sales | x | Sales/Assets | x | Assets/Equity | Explanation of ROE |
| Toll Brothers Inc. | 19% | = | 13% | x | 0.81 | x | 1.74 | High profits over sales are key here |
| Stantec Inc. | 17% | = | 7% | x | 1.03 | x | 2.54 | Good profit over sales, good asset turnover and high equity leverage |
| Shopify Inc. | 15% | = | 17% | x | 0.68 | x | 1.24 | The high profits over sale are key here plus it is asset light |
| Metro Inc. | 15% | = | 5% | x | 1.49 | x | 2.06 | High asset turnover and leverage overcome the low profits on sales |
| Royal Bank of Canada | 14% | = | 30% | x | 0.03 | x | 18.12 | High profits over sales and massive leverage overcome the extremely low asset turnover |
| WSP Global Inc. | 14% | = | 6% | x | 0.91 | x | 2.47 | Good profit over sales plus leverage and relatively high asset turnover |
| Canadian Tire | 11% | = | 4% | x | 0.75 | x | 3.86 | High equity leverage is key here |
| Linamar Corporation | 11% | = | 6% | x | 0.93 | x | 2.00 | Good profit over sales plus leverage and good asset turnover |
| Enbridge Inc. | 10% | = | 12% | x | 0.24 | x | 3.49 | Strong profits over sales and high leverage overcome the low asset turnover |
| Canadian Western Bank | 10% | = | 30% | x | 0.03 | x | 11.87 | High profits over sales and massive leverage overcome the extremely low asset turnover |
| Fortis Inc. | 7% | = | 13% | x | 0.17 | x | 3.29 | High profits over sales and high leverage overcome the very low asset turnover |
| Company | ROE | = | Profit/Sales | x | Sales/Assets | x | Assets/Equity | Explanation of ROE |
| RioCan Real Estate Investment Trust | 7% | = | 45% | x | 0.08 | x | 2.03 | Very high profits over sales are not enough to overcome the very low asset turnover |
| Berkshire Hathaway Inc | 7% | = | 11% | x | 0.32 | x | 1.82 | Low asset turnover but this ROE excludes gains on investment |
| Melcor Developments Ltd. | 6% | = | 22% | x | 0.16 | x | 1.68 | High profits on sales and modest leverage are not enough to offset the very low asset turnover |
| Melcor Real Estate Investment Trust | 6% | = | 21% | x | 0.11 | x | 2.63 | High profits on sales and high leverage are not enough to offset the very low asset turnover |
| Cameco Corporation | 5% | = | 11% | x | 0.27 | x | 1.55 | The low asset turnover and modest leverage lead to low ROE |
| Andrew Peller Limited | 3% | = | 2% | x | 0.70 | x | 2.29 | Low profits on sales with somewhat low asset turnover are problematic |
| LightSpeed Commerce Inc. | 0% | = | 3% | x | 0.11 | x | 1.07 | Negative Trifecta! low profits on sales, Low asset turnover, and limited leverage |
| West Fraser Timber Co. Ltd. | -1% | = | -2% | x | 0.68 | x | 1.30 | Negative profits on sales currently in this cyclic business |
| AutoCanada Inc. | -3% | = | 0% | x | 19.41 | x | 0.63 | Negative profits on sales currently in this cyclic business |
| Aecon Group Inc. | -10% | = | -2% | x | 1.26 | x | 3.42 | Negative profits on sales currently in this cyclic business |
| Company | ROE | = | Profit/Sales | x | Sales/Assets | x | Assets/Equity | Explanation of ROE |
A high ROE company will not necessarily be a good investment especially in the short run. But it’s a great place to look for good investment prospects.
End
Shawn Allen
InvestorsFriend Inc.
December 27, 2024