Analyzing Celanese Corp's ROE

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Oct 14, 2014

In this article, let's see one of the most important financial ratios applying to stockholders, the best measure of performance for a firm's management: the Return on Equity (ROE). We are going to analyze it in the case Celanese Corp (CE, Financial).

ROE is calculated as net income applicable to common shares, divided by the average book value of common equity: ROE = Net Income / Av. Book Value

A higher ROE is viewed as a positive aspect for the company, but the reason behind it should be examined. From the equation above, we can see that if book value is decreasing more rapidly than net income, the ratio will increase, but this is not good for the firm.

Dupont Analysis

This approach can be used to analyze the ROE. With some algebra, we can break down ROE into a function of different ratios. First, we are going to consider the original approach:

Original Dupont Equation: Three-Part Dupont

Taking the ROE equation: ROE = net income / shareholder's equity and multiplying ROE by (revenue / revenue), and rearranging terms we get:

ROE = (net income / revenue) * (revenue / shareholder's equity)

We now have ROE broken into two parts. The first is net profit margin, and the second is the equity turnover ratio. Now we can expand this by multiplying these terms by (assets / assets), and rearranging the terms, we end up with the three-step DuPont equation.

ROE = (Net Income / Revenue) * (Revenue / Assets) * (Assets / Shareholder's Equity)

This equation for ROE breaks it into three widely used and studied components:

ROE = (Net profit margin)* (Asset Turnover) * (Leverage ratio)

The first term is what we called previously net profit margin, the second term is asset turnover and the third term is a financial leverage ratio. If we have a low ROE, one of the following must be true:

  • The firm has a poor profit margin
  • The firm has a poor asset turnover
  • The firm has a little leverage

Extended DuPont Analysis: Five-Step DuPont

Net Profit Margin = Net Income / Revenues can be rewritten using another mathematical identity:

Profit Margin = (Net Income / Earnings Before Taxes) * (Earnings Before Taxes (EBT) / Earnings Before Interest and Taxes (EBIT)) * (EBIT / Revenues)

Tax Burden = (Net Income / Earnings Before Taxes): is an indication of how much the company is paying in corporate taxes, or how much of the profit is falling to the bottom line.

Interest Burden = (Earnings Before Taxes / Earnings Before Interest and Taxes)

Sales Margin = (EBIT / Revenues): is another way of looking at how profitable each dollar of revenue is after deducting operating expenses, but before deducting interest and taxes.

Net Profit Margin = Tax Burden * Interest Burden * Sales Margin

And finally, the complete Extended DuPont Analysis:

ROE = (Net Income / EBT) * (EBT / EBIT) * (EBIT / Sales) * (Sales / Assets) * (Assets / Equity)

ROE = Tax Burden * Interest Burden * Sales Margin * Asset Turnover * Equity Multiplier

Final Comment

As outlined in the article. a key ratio used to determine management efficiency is the ROE. In general, analysts consider ROE ratios in the 15-20% range as representing attractive levels for investment. As we can appreciate, in all of the years the firm reaches those acceptable levels according to what we have just said.

It is very important to understand this metric before investing and it is important to look at the trend in ROE over time.

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During the past 13 years, the highest Return on Equity (ROE) was 450.41%, the lowest was -20.49% and the median was 47.90%.

So based on this analysis, I would recommend investors to consider adding this stock to their long-term portfolios.

Hedge fund guru John Buckingham (Trades, Portfolio) added the stock in the second quarter of 2014.

Disclosure: Omar Venerio holds no position in any stocks mentioned.