BlackRock, Inc (NYSE: BLK) delivered an above average 16.3% ROE over the past year, compared to the 8.3% return generated by the Financials sector. BlackRock’s results may indicate management is running an efficient business relative to its peers, which may very well be the case, but it is important to understand what ROE is made up of and how it should be interpreted. Knowing these components may change your view on BlackRock’s performance and future prospects. I show you exactly what I mean in my DuPont analysis below.
How To Calculate BlackRock’s ROE
Return on equity measures a corporation’s profitability by revealing how much profit a company generates with the money shareholders have invested. Return on Equity or ROE is generally calculated using the following formula:
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. However, it is important to note that ROE can be “manufactured” by management with the use of leverage or debt.
The return on equity achieved by BlackRock over the last few years is shown below.
source: finbox.io data explorer – ROE
The return on equity of BlackRock has generally been declining over the last few years. ROE decreased from 11.9% to 11.0% in fiscal year 2016, increased to 16.3% in 2017 and the LTM period is also its latest fiscal year. So what’s causing the general decline?
Understanding BlackRock’s Declining Return On Equity
The DuPont analysis is another way to calculate a company’s ROE using the following three metrics:
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 what exactly is causing BlackRock’s declining returns?
Net Profit Margin Trends
The net profit margin of BlackRock has generally been declining over the last few years. Margins decreased from 29.3% to 28.4% in fiscal year 2016, increased to 39.8% in 2017 and the LTM period is also its latest fiscal year.
Therefore, the company’s decreasing margins help explain, at least partially, why ROE is also decreasing. Now let’s take a look at BlackRock’s efficiency performance.
Asset Turnover Trends
It appears that asset turnover of BlackRock has generally been increasing over the last few years. Turnover increased from 0.05x to 0.05x in fiscal year 2016, increased to 0.06x in 2017 and the LTM period is also its latest fiscal year.
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 BlackRock’s ROE are shown in the table below. Note that the table also compares BlackRock to a peer group that includes Franklin Resources, Inc. (NYSE: BEN), Invesco Plc (NYSE: IVZ), KKR & Co. L.P. (NYSE: KKR) and The Blackstone Group L.P. (NYSE: BX).
source: finbox.io’s DuPont model
In conclusion, the DuPont analysis has helped us better understand that BlackRock’s general decline in return on equity is the result of a worsening net profit margin, an improving asset turnover ratio and declining leverage. Therefore when looking at the core operations of the business, BlackRock shareholders do not need to be too concerned due to the company’s general decline 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. But before making an investment decision, I recommend you continue to research BlackRock to get a more comprehensive view of the company by looking at:
Valuation Metrics: how much upside do shares of BlackRock 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 BlackRock’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 BlackRock 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.