Pizu Group Holdings Limited (SEHK:8053) delivered an ROE of 57.69% over the past 12 months, which is an impressive feat relative to its industry average of 9.60% during the same period. Superficially, this looks great since we know that 8053 has generated big profits with little equity capital; however, ROE doesn’t tell us how much 8053 has borrowed in debt. In this article, we’ll closely examine some factors like financial leverage to evaluate the sustainability of 8053’s ROE. Check out our latest analysis for Pizu Group Holdings
Breaking down ROE — the mother of all ratios
Firstly, Return on Equity, or ROE, is simply the percentage of last years’ earning against the book value of shareholders’ equity. An ROE of 57.69% implies HK$0.58 returned on every HK$1 invested. 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
Returns are usually compared to costs to measure the efficiency of capital. Pizu Group Holdings’s cost of equity is 8.38%. Given a positive discrepancy of 49.32% between return and cost, this indicates that Pizu Group Holdings pays less for its capital than what it generates in return, which is a sign of capital efficiency. 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
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 Pizu 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 Pizu Group Holdings’s historic debt-to-equity ratio. The debt-to-equity ratio currently stands at a low 46.29%, 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? 8053’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%.