Bed Bath & Beyond Inc.’s (NASDAQ: BBBY) most recent return on equity was an above average 18.6% in comparison to the Consumer Discretionary sector which returned 8.8%. Though Bed Bath & Beyond’s performance over the past twelve months is impressive, it’s useful to understand how the company achieved its healthy ROE. Was it a result of profit margins, operating efficiency or maybe even leverage? Knowing these components may change your views on Bed Bath & Beyond and its future prospects.
ROE Trends Of Bed Bath & Beyond
Return on equity (ROE) is the amount of net income returned as a percentage of shareholders equity. It is calculated as follows:
ROE = Net Income To Common / Average Total Common Equity
ROE is a helpful metric that illustrates how effective the company is at turning the cash put into the business into gains or returns for investors. But it is important to note that ROE can be impacted by management’s financing decisions such as the deployment of leverage.
The return on equity of Bed Bath & Beyond is shown below.
source: finbox.io data explorer – ROE
The return on equity of Bed Bath & Beyond has generally been declining over the last few years. ROE increased from 28.6% to 31.7% in fiscal year 2016, decreased to 26.0% in 2017 and decreased again to 18.6% as of LTM Nov’17. So what’s causing the general decline?
Bed Bath & Beyond’s Declining ROE Trends
In addition to the formula previously discussed, there’s actually another way to calculate ROE. It’s often called the DuPont formula and is as follows:
Return on Equity = Net Profit Margin * Asset Turnover * Equity Multiplier
Analyzing changes in these three items over time allows investors to figure out if operating efficiency, asset use efficiency or the use of leverage is what’s causing changes in ROE. Strong companies should have ROE that is increasing because its net profit margin and/or asset turnover is increasing. On the other hand, a company may not be as strong as investors would otherwise think if ROE is increasing from the use of leverage or debt.
So let’s take a closer look at the drivers behind Bed Bath & Beyond’s returns.
Net Profit Margin
Unfortunately for shareholders, Bed Bath & Beyond’s net profit margin has decreased each year since 2015. Margins decreased from 8.1% to 7.0% in fiscal year 2016, decreased to 5.6% in 2017 and decreased again to 4.1% as of LTM Nov’17.
As a result, the company’s worsening margins help explain, at least in part, why ROE continues to decline. However, let’s also take a look at Bed Bath & Beyond’s efficiency.
It appears that asset turnover of Bed Bath & Beyond has generally been increasing over the last few years. Turnover increased from 1.81x to 1.83x in fiscal year 2016, increased to 1.83x in 2017 and decreased to 1.69x as of LTM Nov’17.
source: data explorer – asset turnover
As a result, the company’s declining ROE is not due to its asset turnover performance which has generally been increasing.
Finally, the DuPont constituents that make up Bed Bath & Beyond’s ROE are shown in the table below. Note that the table also compares Bed Bath & Beyond to a peer group that includes Williams-Sonoma, Inc. (NYSE: WSM), Best Buy Co., Inc. (NYSE: BBY), Restoration Hardware Holdings Inc. (NYSE: RH) and Pier 1 Imports, Inc. (NYSE: PIR).
source: finbox.io’s DuPont model
In conclusion, the DuPont analysis has helped us better understand that Bed Bath & Beyond’s general decline in return on equity is the result of a steadily deteriorating net profit margin, an improving asset turnover ratio and increasing leverage. Therefore when looking at the core operations of the business, Bed Bath & Beyond shareholders have reason to be concerned due to the company’s deteriorating profitability along with a general improvement in operational efficiency and increasing leverage.
The DuPont approach is a helpful tool when analyzing how well management is utilizing shareholder capital. However, it doesn’t necessarily tell the whole story. If you have not done so already, I highly recommend that you complete your research on Bed Bath & Beyond by taking a look at the following:
Valuation Metrics: how much upside do shares of Bed Bath & Beyond have based on the Ben Graham Formula? Take a look at our Ben Graham Formula data explorer which also compares the company’s upside to its peers.
Risk Metrics: what is Bed Bath & Beyond’s Altman Z score? It’s a famous formula used to predict the probability that a firm will go into bankruptcy within two years. View the company’s Altman Z score here.
Efficiency Metrics: how much free cash flow does Bed Bath & Beyond generate as a percentage of total sales? Has it been increasing or decreasing over time? Review the firm’s free cash flow margin here.
As of this writing, I did not hold a position in any of the aforementioned securities and this is not a buy or sell recommendation on any security mentioned.