APAC Realty Limited (SGX:CLN) outperformed the Real Estate Services industry on the basis of its ROE – producing a higher 22.39% relative to the peer average of 7.37% over the past 12 months. Superficially, this looks great since we know that CLN has generated big profits with little equity capital; however, ROE doesn’t tell us how much CLN has borrowed in debt. Today, we’ll take a closer look at some factors like financial leverage to see how sustainable CLN’s ROE is. View our latest analysis for APAC Realty
Breaking down Return on Equity
Return on Equity (ROE) is a measure of APAC Realty’s profit relative to its shareholders’ equity. It essentially shows how much the company can generate in earnings given the amount of equity it has raised. 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
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 APAC Realty, which is 8.38%. This means APAC Realty returns enough to cover its own cost of equity, with a buffer of 14.01%. This sustainable practice implies that the company pays less for its capital than what it generates in return. ROE can be dissected into three distinct 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
Essentially, profit margin shows how much money the company makes after paying for all its expenses. The other component, asset turnover, illustrates how much revenue APAC Realty can make from its asset base. And finally, financial leverage is simply how much of assets are funded by equity, which exhibits how sustainable the company’s capital structure is. Since ROE can be inflated by excessive debt, we need to examine APAC Realty’s debt-to-equity level. Currently, APAC Realty has no debt which means its returns are driven purely by equity capital. Therefore, the level of financial leverage has no impact on ROE, and the ratio is a representative measure of the efficiency of all its capital employed firm-wide.
What this means for you:
Are you a shareholder? CLN exhibits a strong ROE against its peers, as well as sufficient returns to cover 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%.