for the two companies: UPS 16.6%, FDX 11.6%. But how UPS manages to generate a higher return on equity may come as a surprise to many.
To demonstrate how UPS generates the higher return on equity (ROE), it's useful to examine the following equation: ROE = Net Income / Equity
ROE can be further broken down into (Net Income / Assets) * (Assets / Equity).
In other words, we can break down a company's return on equity as a combination of its return on assets (Net Income / Assets) and its
use of leverage (Assets / Equity).
But for both FDX and UPS, return on assets sits at 6.3%! This means the major difference between the ROE for these two companies comes from differing uses of leverage. Indeed, the debt to capital ratio for FDX sits at just 13% compared to 44% for UPS. This means UPS hasn't generated its superior returns through better operations, but rather by using cheaper
capital (debt) while taking more risk as a result.
Should UPS pay down its debt so that its risk level isn't so high, or should FDX take advantage of cheaper capital in order to
generate more returns for shareholders? We'll explore these questions in a future post.
*To smooth out fluctations, ratios in this article were taken using the average of the last two fiscal years of each company.
By Barel Karsan, www.barelkarsan.com
About the author:_____________
Sascha Seiler is a Finance student in Stuttgart, Germany besides working for a major german bank. Simply trying to buy fractions of wonderful businesses that are run by able people - at fair prices - and then holding on to them forever. This practically means cloning Mr. Buffetts framework. Investment blog (in german): www.intelligentinvestieren.blogspot.com