Easy Repay Finance & Investment Limited (SEHK:8079) generated a below-average return on equity of 5.49% in the past 12 months, while its industry returned 11.77%. 8079’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 8079’s performance. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of 8079’s returns. Let me show you what I mean by this. Check out our latest analysis for Easy Repay Finance & Investment
Breaking down Return on Equity
Return on Equity (ROE) weighs Easy Repay Finance & Investment’s profit against the level of its shareholders’ equity. An ROE of 5.49% implies HK$0.05 returned on every HK$1 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
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 Easy Repay Finance & Investment, which is 8.38%. Since Easy Repay Finance & Investment’s return does not cover its cost, with a difference of -2.89%, this means its current use of equity is not efficient and not sustainable. Very simply, Easy Repay Finance & Investment pays more 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
Basically, profit margin measures how much of revenue trickles down into earnings which illustrates how efficient the business is with its cost management. Asset turnover reveals how much revenue can be generated from Easy Repay Finance & Investment’s 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 financial leverage can artificially inflate ROE, we need to look at how much debt Easy Repay Finance & Investment currently has. Currently the debt-to-equity ratio stands at a low 1.61%, which means Easy Repay Finance & Investment still has headroom to take on more leverage in order to increase profits.