With an ROE of 21.14%, Kin Yat Holdings Limited (SEHK:638) outpaced its own industry which delivered a less exciting 9.62% over the past year. While the impressive ratio tells us that 638 has made significant profits from little equity capital, ROE doesn’t tell us if 638 has borrowed debt to make this happen. Today, we’ll take a closer look at some factors like financial leverage to see how sustainable 638’s ROE is. View our latest analysis for Kin Yat Holdings
Breaking down Return on Equity
Return on Equity (ROE) weighs 638’s profit against the level of its shareholders’ equity. It essentially shows how much 638 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 measured against cost of equity in order to determine the efficiency of 638’s equity capital deployed. Its cost of equity is 11.28%. This means 638 returns enough to cover its own cost of equity, with a buffer of 9.86%. 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. Asset turnover reveals how much revenue can be generated from 638’s asset base. And finally, financial leverage is simply how much of assets are funded by equity, which exhibits how sustainable 638’s capital structure is. Since financial leverage can artificially inflate ROE, we need to look at how much debt 638 currently has. The debt-to-equity ratio currently stands at a low 35.31%, 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? 638’s above-industry ROE is encouraging, and is also in excess of 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%.