RealPage, Inc. (NASDAQ: RP) delivered a below average 0.6% ROE over the past year, compared to the 2.9% return generated by the Information Technology sector. RealPage’s results may indicate management is running an inefficient 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 RealPage’s performance and future prospects. I show you exactly what I mean in my DuPont analysis below.
How To Calculate RealPage’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 RealPage over the last few years is shown below.
source: finbox.io data explorer – ROE
It appears that the return on equity of RealPage has generally been increasing over the last few years. ROE increased from -2.8% to 4.7% in fiscal year 2016, decreased to 0.1% in 2017 and increased to 0.6% as of LTM Mar’18. So what’s causing the general improvement?
Understanding RealPage’s Improving 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 RealPage’s improving returns?
Net Profit Margin Trends
It appears that the net profit margin of RealPage has generally been increasing over the last few years. Margins increased from -2.0% to 2.9% in fiscal year 2016, decreased to 0.1% in 2017 and increased to 0.4% as of LTM Mar’18.
Therefore, the company’s increasing margins help explain, at least partially, why ROE is also increasing. Now let’s take a look at RealPage’s efficiency performance to see if that is also boosting ROE.
Asset Turnover Trends
It appears that asset turnover of RealPage has generally been increasing over the last few years. Turnover increased from 0.79x to 0.81x in fiscal year 2016, decreased to 0.58x in 2017 and increased to 0.60x as of LTM Mar’18.
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 RealPage’s ROE are shown in the table below. Note that the table also compares RealPage to a peer group that includes Tyler Technologies, Inc. (NYSE: TYL), Ellie Mae, Inc. (NYSE: ELLI), Fair Isaac Corporation (NYSE: FICO) and Guidewire Software, Inc. (NYSE: GWRE).
source: finbox.io’s DuPont model
In conclusion, the DuPont analysis has helped us better understand that RealPage’s general improvement in return on equity is the result of an improving net profit margin, an improving asset turnover ratio and increasing leverage. Therefore when looking at the core operations of the business, RealPage shareholders have reason to be excited due to the company’s general improvement in 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. But before making an investment decision, I recommend you continue to research RealPage to get a more comprehensive view of the company by looking at:
Valuation Metrics: what is RealPage’s short ratio and how does it compare to its publicly traded peers? It represents the percentage of total shares outstanding that is being shorted. View the short ratio here.
Risk Metrics: how much interest coverage does RealPage have? This is a ratio used to assess a firm’s ability to pay interest expenses based on operating profits (EBIT). View the company’s interest coverage here.
Efficiency Metrics: fixed asset turnover is calculated by dividing revenue by average fixed assets. View RealPage’s fixed asset turnover 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.