Imdex Limited’s (ASX:IMD) most recent return on equity was a substandard 1.86% relative to its industry performance of 12.40% over the past year. IMD’s results could indicate a relatively inefficient operation to its peers.
ROE is assessed against cost of equity, which is measured using the Capital Asset Pricing Model (CAPM) – but let’s not dive into the details of that today. For now, let’s just look at the cost of equity number for IMD, which is 9.71%. Given a discrepancy of -7.85% between return and cost, this indicated that IMD may be paying more for its capital than what it’s generating in return.
ROE = profit margin × asset turnover × financial leverage = (annual net profit ÷ sales) × (sales ÷ assets) × (assets ÷ shareholders’ equity)
We should look at IMD’s debt-to-equity ratio to examine sustainability of its returns. Currently the ratio stands at 4.47%, which is very low. This means IMD has not taken on leverage, which could explain its below-average ROE. IMD still has headroom to take on more leverage in order to grow its returns.
IMD’s current assets ($80M) easily cover the total debt ($13M), giving it enough control on its balance sheet to survive a downturn.
In IMD’s case, the company is making a loss, therefore interest on debt is not well covered by earnings.
Numerous companies exposed to the mining sector are set to benefit from China’s continued growth. We have positioned our investment portfolio to gain exposure to this trend through positions in mining services companies such as, mining technology business Imdex (ASX: IMD) and, with a mining equipment hire business, Seven Group Holdings (ASX: SVW).