Will Highland Gold Mining Limited (LON:HGM) Continue To Underperform Its Industry?
This article is intended for those of you who are at the beginning of your investing journey and want a simplistic look at the return on Highland Gold Mining Limited (LON:HGM) stock.
Highland Gold Mining Limited’s (LON:HGM) most recent return on equity was a substandard 8.47% relative to its industry performance of 10.94% over the past year. HGM’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 HGM’s performance. Today I will look at how components such as financial leverage can influence ROE which may impact the sustainability of HGM’s returns. Check out our latest analysis for Highland Gold Mining
Breaking down Return on Equity
Return on Equity (ROE) weighs Highland Gold Mining’s profit against the level of its shareholders’ equity. An ROE of 8.47% implies £0.085 returned on every £1 invested. 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 Highland Gold Mining, which is 11.27%. Since Highland Gold Mining’s return does not cover its cost, with a difference of -2.80%, this means its current use of equity is not efficient and not sustainable. Very simply, Highland Gold Mining pays more for its capital than what it generates 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 the business is with its cost management. The other component, asset turnover, illustrates how much revenue Highland Gold Mining can make from its asset base. And finally, financial leverage is simply how much of assets are funded by equity, which exhibits how sustainable the company’s capital structure is. Since financial leverage can artificially inflate ROE, we need to look at how much debt Highland Gold Mining currently has. Currently the debt-to-equity ratio stands at a low 27.10%, which means Highland Gold Mining still has headroom to take on more leverage in order to increase profits.
Next Steps:
ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. Highland Gold Mining’s below-industry ROE is disappointing, furthermore, its returns were not even high enough to cover its own cost of equity. Although, its appropriate level of leverage means investors can be more confident in the sustainability of Highland Gold Mining’s return with a possible increase should the company decide to increase its debt levels. Although ROE can be a useful metric, it is only a small part of diligent research.
For Highland Gold Mining, I’ve compiled three important aspects you should further research:
Financial Health: Does it have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
Valuation: What is Highland Gold Mining worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether Highland Gold Mining is currently mispriced by the market.
Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Highland Gold Mining? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!
To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned.
