Verizon Communications Inc. (NYSE: VZ) is one of the largest telecommunications companies in the world and the second-largest in the United States by market capitalization. For the 12 months ending in September 2015, the company reported net income of $10.3 billion and average total shareholder equity of $14.9 billion, resulting in return on equity (ROE) of 69.1%. This is very high relative to its peers and its historical performance. While its net margin, asset turnover and high financial leverage all contribute to the high ROE, an exceptionally high equity multiplier is the primary driver of Verizon's high ROE.

Historical and Peer Comparisons

Verizon's 69.1% ROE for the 12 months ending in September 2015 is by far the highest value returned by the company in recent years, though its ROE was also very high in 2013 and 2014 at 32% and 38%, respectively. Though net income has not increased significantly in recent years, the value of shareholder equity has declined, with cash and equivalents falling while long-term debt rises. For large-cap diversified global telecommunications service providers, the average ROE over the 12 months ending in September 2015 was 6.9%. Bell Canada and Telefonica have the highest ROE among Verizon's peers, at 22.5% and 21.2%, respectively. For the full years 2009 through 2012, Verizon reported ROE in line with the peer group averages.

DuPont Analysis

By separating ROE into constituent elements, analysts can individually examine the various factors driving ROE over time or relative to competitors. ROE can be calculated by multiplying net margin by asset turnover ratio and the equity multiplier, and each metric provides information about different aspects of the business.

Verizon's net margin was 7.86% for the 12 months ending in September 2015. This is high relative to most historical results, but its net profit margin rose above 9% in 2013 and 2005. The recent results still mark an improvement relative to the prior year, and the company is maintaining much higher ROE than in 2009 to 2012, when net margin never topped 3.4%. Verizon also compares favorably to its peers, having one of the highest net margins of the group. The large-cap telecommunications service provider industry average net profit margin is 4.1%, with Bell Canada and Telefonica notching the widest margins at 12% and 8.4%, respectively.

Verizon's asset turnover ratio was 0.56 for the 12 months ending in September 2015. This is the highest value of the past decade, and it marks the second straight sequential increase. The lowest asset turnover the company has reported in recent years is 0.48 in 2010, creating the lower bound for a narrow range of values. Over the past three years, its revenue has increased while its total asset value has decreased, leading to lower asset turnover. Verizon's asset turnover is also the highest among its industry peers, which have an average value of 0.45. The distribution of asset turnover ratios among peer group constituents is also narrow, with only one company falling below 0.4. Investors can conclude that this ratio is a modest contributor to Verizon's high ROE.

Verizon's equity multiplier was 18.4 for the year ending in September 2015. This is very high compared to recent historical levels, with only 2014 having a higher equity multiplier at 18.92. The financial leverage ratio for every other full year in the past decade fell between 3.7 and 7.1. Falling cash and rising long-term debt have caused a drop in shareholder equity that has outpaced the decline in total asset value, indicating an increasing use of debt to finance the company's assets. This reflects a significant change in capital structure. Verizon's peers have an average equity multiplier of 3.4, with no company having a financial leverage ratio over 6.1. Verizon's new capital structure employs much higher leverage than comparable companies, and the magnitude of this gap is the primary factor driving higher ROE for the firm.

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