Dickson Concepts (International) Limited’s (SEHK:113) most recent return on equity was a substandard 4.28% relative to its industry performance of 8.60% over the past year. 113’s results could indicate a relatively inefficient operation to its peers, and while this may be the case, it is important to understand what ROE is made up of and how it should be interpreted. Knowing these components could change your view on 113’s performance. Today I will look at how components such as financial leverage can influence ROE which may impact the sustainability of 113’s returns. View our latest analysis for Dickson Concepts (International)
What you must know about ROE
Return on Equity (ROE) weighs 113’s profit against the level of its shareholders’ equity. An ROE of 4.28% implies HK$0.04 returned on every HK$1 invested. While a higher ROE is preferred in most cases, there are several other factors we should consider before drawing any conclusions.
Return on Equity = Net Profit ÷ Shareholders Equity
ROE is measured against cost of equity in order to determine the efficiency of 113’s equity capital deployed. Its cost of equity is 9.13%. Given a discrepancy of -4.85% between return and cost, this indicated that 113 may be paying more for its capital than what it’s generating 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
Basically, profit margin measures how much of revenue trickles down into earnings which illustrates how efficient 113 is with its cost management. Asset turnover shows how much revenue 113 can generate with its current asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. Since financial leverage can artificially inflate ROE, we need to look at how much debt 113 currently has. Currently the debt-to-equity ratio stands at a low 3.18%, which means 113 still has headroom to take on more leverage in order to increase profits.
What this means for you:
Are you a shareholder? 113’s ROE is underwhelming relative to the industry average, and its returns were also not strong enough to cover its own cost of equity. Since its existing ROE is not fuelled by unsustainable debt, investors shouldn’t give up as 113 still has capacity to improve shareholder returns by borrowing to invest in new projects in the future. 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%.