Asian Pay Television Trust (SGX:S7OU) generated a below-average return on equity of 3.46% in the past 12 months, while its industry returned 9.34%. S7OU’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 S7OU’s performance. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of S7OU’s returns. Let me show you what I mean by this. See our latest analysis for S7OU
Breaking down Return on Equity
Firstly, Return on Equity, or ROE, is simply the percentage of last years’ earning against the book value of shareholders’ equity. It essentially shows how much S7OU can generate in earnings given the amount of equity it has raised. While a higher ROE is preferred in most cases, there are several other factors we should consider before drawing any conclusions.
Return on Equity = Net Profit ÷ Shareholders Equity
ROE is measured against cost of equity in order to determine the efficiency of S7OU’s equity capital deployed. Its cost of equity is 9.82%. Given a discrepancy of -6.36% between return and cost, this indicated that S7OU 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
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 S7OU’s asset base. And finally, financial leverage is simply how much of assets are funded by equity, which exhibits how sustainable S7OU’s capital structure is. Since financial leverage can artificially inflate ROE, we need to look at how much debt S7OU currently has. Currently the debt-to-equity ratio stands at a balanced 114.60%, which means its ROE is driven by its ability to grow its profit without a significant debt burden.
What this means for you:
Are you a shareholder? S7OU exhibits a weak ROE against its peers, as well as insufficient levels to cover its own cost of equity this year. However, investors shouldn’t despair since ROE is not inflated by excessive debt, which means S7OU still has room to improve shareholder returns by raising debt to fund new investments. 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%.