ROE decomposition breaks down the return on equity into three parts representing profitability, asset turnover and financial leverage. According to (Milbourn, Gene & Haight, 47), return on equity is estimated as the product of profit margin, asset turnover and financial leverage.
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Profit margin estimates the measures the profitability of a business. It is the percentage of revenue which remains after accounting for the cost of revenue and operating costs (Saleem & Rehman, 95). High profit margin indicates higher profitability. Asset turnover estimates the efficiency with which a business utilizes the available assets to generate revenue (Milbourn, Gene & Haight, 47). Increase in asset turn over implies that a business generates more revenue per asset owned. Financial leverage compares the amount of debt that a company utilizes to finance debt relative to the amount of equity used. Use of more debt means that the company is taking advantage of the tax advantage available interest paid on debt (Saleem & Rehman, 95). The ROE, therefore, increases with an increase in profitability, asset turnover and financial leverage.
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Kroger has the highest level of ROE in all the three years, followed by Costo, while Walmart has the least. The ROE for Kroger increases significantly between 2018 and 2019 while that of Cot remains fairly constant. The ROE of Walmart, however, decrease significantly over the three years, implying declining profitability, financial leverage and asset turnover. To increase the ROE, Walmart should focus on growing sales and reducing the related costs (Milbourn, Gene & Haight, 47). This can be done by focusing on expanding the online retailer section over the traditional brick and mortar stores. Online retailing will help Walmart in gaining a competitive edge against competitors such as Amazon. Although online retailing has a high initial cost, the cost of operation is significantly low as compared to brick and mortar. Coping with dynamic consumer preferences require innovativeness and investment in technology, such as same-day delivery using unmanned aerial vehicles. Walmart should consider using more debt to fund the initial investment to increase financial leverage.
Work Cited
Milbourn, Gene, and Tim Haight. "Providing students with an overview of financial statements using the Dupont analysis approach." Journal of American Academy of Business 6.1 (2005): 46-50.
Saleem, Qasim, and Ramiz Ur Rehman. "Impacts of liquidity ratios on profitability." Interdisciplinary journal of research in business 1.7 (2011): 95-98.
