In This Article:
The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to begin learning the link between company’s fundamentals and stock market performance.
Genes Tech Group Holdings Company Limited (HKG:8257) delivered an ROE of 8.5% over the past 12 months, which is an impressive feat relative to its industry average of 8.3% during the same period. On the surface, this looks fantastic since we know that 8257 has made large profits from little equity capital; however, ROE doesn’t tell us if management have borrowed heavily to make this happen. Today, we’ll take a closer look at some factors like financial leverage to see how sustainable 8257’s ROE is.
View our latest analysis for Genes Tech Group Holdings
What you must know about ROE
Return on Equity (ROE) is a measure of Genes Tech Group Holdings’s profit relative to its shareholders’ equity. For example, if the company invests HK$1 in the form of equity, it will generate HK$0.085 in earnings from this. 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 Genes Tech Group Holdings’s equity capital deployed. Its cost of equity is 10.7%. This means Genes Tech Group Holdings’s returns actually do not cover its own cost of equity, with a discrepancy of -2.2%. This isn’t sustainable as it implies, very simply, that the company 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
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 Genes Tech Group Holdings’s asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. Since ROE can be artificially increased through excessive borrowing, we should check Genes Tech Group Holdings’s historic debt-to-equity ratio. Currently the debt-to-equity ratio stands at a balanced 95.7%, which means its above-average ROE is driven by its ability to grow its profit without a significant debt burden.