GSH Corporation Limited (SGX:BDX) delivered an ROE of 15.87% over the past 12 months, which is an impressive feat relative to its industry average of 7.37% during the same period. Superficially, this looks great since we know that BDX has generated big profits with little equity capital; however, ROE doesn’t tell us how much BDX has borrowed in debt. Today, we’ll take a closer look at some factors like financial leverage to see how sustainable BDX’s ROE is. See our latest analysis for GSH
Breaking down Return on Equity
Return on Equity (ROE) is a measure of GSH’s profit relative to its shareholders’ equity. For example, if the company invests SGD1 in the form of equity, it will generate SGD0.16 in earnings from this. Generally speaking, a higher ROE is preferred; however, there are other factors we must also consider before making any conclusions.
Return on Equity = Net Profit ÷ Shareholders Equity
ROE is measured against cost of equity in order to determine the efficiency of GSH’s equity capital deployed. Its cost of equity is 8.38%. Given a positive discrepancy of 7.49% between return and cost, this indicates that GSH pays less for its capital than what it generates in return, which is a sign of capital efficiency. 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
The first component is profit margin, which measures how much of sales is retained after the company pays for all its expenses. Asset turnover reveals how much revenue can be generated from GSH’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 GSH’s historic debt-to-equity ratio. Currently the debt-to-equity ratio stands at a reasonable 66.52%, which means its above-average ROE is driven by its ability to grow its profit without a significant debt burden.
What this means for you:
Are you a shareholder? BDX’s ROE is impressive relative to the industry average and also covers its cost of equity. Since ROE is not inflated by excessive debt, it might be a good time to add more of BDX to your portfolio if your personal research is confirming what the ROE is telling you. 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%.