Sabra Health Care REIT Inc (NASDAQ:SBRA) generated a below-average return on equity of 8.72% in the past 12 months, while its industry returned 9.04%. SBRA’s results could indicate a relatively inefficient operation to its peers, and while this may be the case, it is important to understand what ROE is made up of and how it should be interpreted. Knowing these components could change your view on SBRA’s performance. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of SBRA’s returns. Let me show you what I mean by this. View our latest analysis for Sabra Health Care REIT
What you must know about ROE
Return on Equity (ROE) weighs SBRA’s profit against the level of its shareholders’ equity.An ROE of 8.72% implies $0.09 returned on every $1 invested, so the higher the return, the better.Investors seeking to maximise their return in the Healthcare REITs industry may want to choose the highest returning stock.However, this can be deceiving as each company has varying costs of equity and debt levels, which could exaggeratedly push up ROE at the same time as accumulating high interest expense.
Return on Equity = Net Profit ÷ Shareholders Equity
Returns are usually compared to costs to measure the efficiency of capital. SBRA’s cost of equity is 8.49%. While SBRA’s peers may have higher ROE, it may also incur higher cost of equity. An undesirable and unsustainable practice would be if returns exceeded cost. However, this is not the case for SBRA which is encouraging. ROE can be split up into three useful 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’ equity
Essentially, profit margin shows how much money the company makes after paying for all its expenses.Asset turnover shows how much revenue SBRA 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 SBRA’s capital structure is.We can determine if SBRA’s ROE is inflated by borrowing high levels of debt. Generally, a balanced capital structure means its returns will be sustainable over the long run. We can examine this by looking at SBRA’s debt-to-equity ratio. The most recent ratio is 122.43%, which is relatively proportionate and indicates SBRA has not taken on extreme leverage. Thus, we can conclude its current ROE is generated from its capacity to increase profit without a massive debt burden.
ROE – It’s not just another ratio
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. Although SBRA’s ROE is underwhelming relative to the industry average, its returns are high enough to cover the cost of equity. Its appropriate level of leverage means investors can be more confident in the sustainability of SBRA’s return with a possible increase should the company decide to increase its debt levels. However, there are other crucial measures we need to account for before determining whether or not its returns are sustainable. I recommend you see our latest FREE analysis report to find out more about these measures!
If you are not interested in SBRA anymore, you can use our free platform to see my list of stocks with Return on Equity over 20%.
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