With an ROE of 19.79%, Ascendas India Trust (SGX:CY6U) outpaced its own industry which delivered a less exciting 7.37% over the past year. While the impressive ratio tells us that CY6U has made significant profits from little equity capital, ROE doesn’t tell us if CY6U has borrowed debt to make this happen. In this article, we’ll closely examine some factors like financial leverage to evaluate the sustainability of CY6U’s ROE. View our latest analysis for Ascendas India Trust
What you must know about ROE
Return on Equity (ROE) weighs Ascendas India Trust’s profit against the level of its shareholders’ equity. An ROE of 19.79% implies SGD0.2 returned on every SGD1 invested. In most cases, a higher ROE is preferred; however, there are many other factors we must consider prior to making any investment decisions.
Return on Equity = Net Profit ÷ Shareholders Equity
Returns are usually compared to costs to measure the efficiency of capital. Ascendas India Trust’s cost of equity is 8.38%. This means Ascendas India Trust returns enough to cover its own cost of equity, with a buffer of 11.42%. This sustainable practice implies that the company pays less for its capital than what it generates in return. ROE can be split up into three useful ratios: net profit margin, asset turnover, and financial leverage. This is called the Dupont Formula:
Dupont Formula
ROE = profit margin × asset turnover × financial leverage
ROE = (annual net profit ÷ sales) × (sales ÷ assets) × (assets ÷ shareholders’ equity)
ROE = annual net profit ÷ shareholders’ equity
The first component is profit margin, which measures how much of sales is retained after the company pays for all its expenses. Asset turnover shows how much revenue Ascendas India Trust can generate with its current asset base. Finally, financial leverage will be our main focus today. It shows how much of assets are funded by equity and can show how sustainable the company’s capital structure is. Since ROE can be inflated by excessive debt, we need to examine Ascendas India Trust’s debt-to-equity level. The debt-to-equity ratio currently stands at a sensible 60.02%, meaning the above-average ROE is due to its capacity to produce profit growth without a huge debt burden.
What this means for you:
Are you a shareholder? CY6U’s ROE is impressive relative to the industry average and also covers its cost of equity. Since its high ROE is not likely driven by high debt, it might be a good time to top up on your current holdings if your fundamental research reaffirms this analysis. If you’re looking for new ideas for high-returning stocks, you should take a look at our free platform to see the list of stocks with Return on Equity over 20%.