YuMe, Inc. (NYSE: YUME) delivered an above average 10.2% ROE over the past year, compared to the 3.0% return generated by the Information Technology sector. YuMe’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 YuMe’s performance and future prospects. I show you exactly what I mean in my DuPont analysis below.
How To Calculate YuMe’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 YuMe over the last few years is shown below.
source: finbox.io data explorer – ROE
It appears that the return on equity of YuMe has generally been increasing over the last few years. ROE decreased from -8.2% to -15.9% in fiscal year 2015, increased to -7.7% in 2016 and increased again to 10.2% as of LTM Sep’17. So what’s causing the general improvement?
Understanding YuMe’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 YuMe’s improving returns?
Net Profit Margin Trends
It appears that the net profit margin of YuMe has generally been increasing over the last few years. Margins decreased from -4.9% to -9.7% in fiscal year 2015, increased to -4.8% in 2016 and increased again to 5.3% as of LTM Sep’17.
Therefore, the company’s increasing margins help explain, at least partially, why ROE is also increasing. Now let’s take a look at YuMe’s efficiency performance to see if that is also boosting ROE.
Asset Turnover Trends
It appears that asset turnover of YuMe has generally been declining over the last few years. Turnover decreased from 1.18x to 1.14x in fiscal year 2015, decreased to 1.12x in 2016 and increased to 1.31x as of LTM Sep’17.
source: data explorer – asset turnover
Therefore, the company’s ROE improvement is not as a result of its asset turnover performance which has generally been decreasing.
Finally, the DuPont constituents that make up YuMe’s ROE are shown in the table below. Note that the table also compares YuMe to a peer group that includes The Rubicon Project, Inc.(NYSE: RUBI), Rocket Fuel Inc. (NASDAQ: FUEL), Brightcove Inc. (NASDAQ: BCOV) and Bitauto Holdings Limited (NYSE: BITA).
source: finbox.io’s DuPont model
In conclusion, the DuPont analysis has helped us better understand that YuMe’s general improvement in return on equity is the result of an improving net profit margin, a declining asset turnover ratio and increasing leverage. Therefore when looking at the core operations of the business, YuMe shareholders may need to start worrying due to the company’s general improvement in profitability along with a general decline 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 YuMe to get a more comprehensive view of the company by looking at:
Valuation Metrics: what is YuMe’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 YuMe’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.