Facebook, Inc.’s (NASDAQ: FB) most recent return on equity was an outstanding 23.8% in comparison to the Information Technology sector which returned 3.8%. Though Facebook’s performance over the past twelve months is highly impressive, it’s useful to understand how the company achieved its strong ROE. Was it a result of profit margins, operating efficiency or maybe even leverage? Knowing these components may change your views on Facebook and its future prospects.
ROE Trends Of Facebook
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 Facebook is shown below.
source: finbox.io data explorer – ROE
It appears that the return on equity of Facebook has generally been increasing over the last few years. ROE increased from 9.1% to 19.7% in fiscal year 2016, increased to 23.8% in 2017 and the LTM period is also its latest fiscal year. So what’s causing the general improvement?
Facebook’s Improving 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 Facebook’s returns.
Net Profit Margin
It appears that the net profit margin of Facebook has generally been increasing over the last few years. Margins increased from 20.5% to 36.9% in fiscal year 2016, increased to 39.2% in 2017 and the LTM period is also its latest fiscal year.
Therefore, the company’s increasing margins help explain, at least partially, why ROE is also increasing. Now let’s take a look at Facebook’s efficiency performance to see if that is also boosting ROE.
It appears that asset turnover of Facebook has generally been increasing over the last few years. Turnover increased from 0.40x to 0.48x in fiscal year 2016, increased to 0.54x in 2017 and the LTM period is also its latest fiscal year.
source: data explorer – asset turnover
Therefore, the company’s increasing asset turnover ratio helps explain, at least in part, why ROE is also increasing.
Finally, the DuPont constituents that make up Facebook’s ROE are shown in the table below. Note that the table also compares Facebook to a peer group that includes Twitter, Inc. (NYSE: TWTR), Tencent Holding Ltd. (NYSE: TCEHY), Alibaba Group Holding Limited (NYSE: BABA) and Spark Networks, Inc. (NYSE: LOV).
source: finbox.io’s DuPont model
In conclusion, the DuPont analysis has helped us better understand that Facebook’s general improvement in return on equity is the result of an improving net profit margin, an improving asset turnover ratio and declining leverage. Therefore when looking at the core operations of the business, Facebook shareholders have reason to be excited due to the company’s general improvement in profitability along with a general improvement in operational efficiency and declining 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 Facebook by taking a look at the following:
Valuation Metrics: what is Facebook’s EBITDA less CapEx multiple and how does it compare to its peers? This is a helpful multiple to analyze when comparing capital intensive businesses. View the company’s EBITDA less CapEx multiple here.
Risk Metrics: what is Facebook’s asset efficiency? This ratio measures the amount of cash flow that a company generates from its assets. View the company’s asset efficiency here.
Efficiency Metrics: is management becoming more or less efficient in creating value for the firm? Find out by analyzing the company’s return on invested capital ratio 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.