Why BCA Marketplace plc (LSE:BCA) May Not Be As Efficient As Its Industry

BCA Marketplace plc ( LSE:BCA ) delivered a less impressive 3.57% ROE over the past year, compared to the 16.11% return generated by its industry. Though BCA'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 BCA's below-average returns. Today I will look at how components such as financial leverage can influence ROE which may impact the sustainability of BCA's returns. Check out our latest analysis for BCA Marketplace

Breaking down Return on Equity

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 BCA can generate in earnings given the amount of equity it has raised. 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

ROE is assessed against cost of equity, which is measured using the Capital Asset Pricing Model (CAPM) – but let's not dive into the details of that today. For now, let's just look at the cost of equity number for BCA, which is 8.30%. Given a discrepancy of -4.73% between return and cost, this indicated that BCA may be paying more for its capital than what it's generating 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 BCA is with its cost management. Asset turnover reveals how much revenue can be generated from BCA's asset base. And finally, financial leverage is simply how much of assets are funded by equity, which exhibits how sustainable BCA's capital structure is. Since ROE can be inflated by excessive debt, we need to examine BCA's debt-to-equity level. Currently the debt-to-equity ratio stands at a low 38.47%, which means BCA still has headroom to take on more leverage in order to increase profits.

What this means for you:

Are you a shareholder?BCA's below-industry ROE is disappointing, furthermore, its returns were not even high enough to cover its own cost of equity. However, investors shouldn't despair since ROE is not inflated by excessive debt, which means BCA still has room to improve shareholder returns by raising debt to fund new investments.