With an ROE of 4.95%, UOB-Kay Hian Holdings Limited (SGX:U10) outpaced its own industry which delivered a less exciting 4.95% over the past year. On the surface, this looks fantastic since we know that U10 has made large profits from little equity capital; however, ROE doesn’t tell us if management have borrowed heavily to make this happen. In this article, we’ll closely examine some factors like financial leverage to evaluate the sustainability of U10’s ROE. View our latest analysis for UOB-Kay Hian Holdings
Breaking down Return on Equity
Return on Equity (ROE) is a measure of UOB-Kay Hian Holdings’s profit relative to its shareholders’ equity. For example, if the company invests SGD1 in the form of equity, it will generate SGD0.05 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 UOB-Kay Hian Holdings’s equity capital deployed. Its cost of equity is 8.38%. 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 UOB-Kay Hian Holdings’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 artificially increased through excessive borrowing, we should check UOB-Kay Hian Holdings’s historic debt-to-equity ratio. The debt-to-equity ratio currently stands at a sensible 51.39%, meaning the ROE is a result of its capacity to produce profit growth without a huge debt burden.
What this means for you:
Are you a shareholder? U10 exhibits a strong ROE against its peers, however it was not high enough to cover its own cost of equity this year. Since its high ROE is not fuelled by unsustainable debt, investors shouldn’t give up as U10 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%.