Procurri Corporation Limited’s (SGX:BVQ) most recent return on equity was a substandard 1.24% relative to its industry performance of 11.65% over the past year. BVQ’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 BVQ’s performance. Today I will look at how components such as financial leverage can influence ROE which may impact the sustainability of BVQ’s returns. View our latest analysis for Procurri
Breaking down ROE — the mother of all ratios
Return on Equity (ROE) weighs Procurri’s profit against the level of its shareholders’ equity. It essentially shows how much the company 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
Returns are usually compared to costs to measure the efficiency of capital. Procurri’s cost of equity is 8.38%. Given a discrepancy of -7.13% between return and cost, this indicated that Procurri may be paying more for its capital than what it’s generating in return. 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
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 Procurri’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 ROE can be inflated by excessive debt, we need to examine Procurri’s debt-to-equity level. Currently the debt-to-equity ratio stands at a low 39.69%, which means Procurri still has headroom to take on more leverage in order to increase profits.
What this means for you:
Are you a shareholder? BVQ exhibits a weak ROE against its peers, as well as insufficient levels to cover its own cost of equity this year. Since its existing ROE is not fuelled by unsustainable debt, investors shouldn’t give up as BVQ still has capacity to improve shareholder returns by borrowing to invest in new projects in the future. 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%.