Grand T G Gold Holdings Limited (SEHK:8299) generated a below-average return on equity of 4.37% in the past 12 months, while its industry returned 8.54%. Though 8299’s recent performance is underwhelming, it is useful to understand what ROE is made up of and how it should be interpreted. Knowing these components can change your views on 8299’s below-average returns. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of 8299’s returns. Let me show you what I mean by this. See our latest analysis for 8299
Breaking down Return on Equity
Return on Equity (ROE) is a measure of 8299’s profit relative to its shareholders’ equity. An ROE of 4.37% implies HK$0.04 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
ROE is measured against cost of equity in order to determine the efficiency of 8299’s equity capital deployed. Its cost of equity is 13.77%. Since 8299’s return does not cover its cost, with a difference of -9.40%, this means its current use of equity is not efficient and not sustainable. Very simply, 8299 pays more for its capital than what it generates 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 8299 is with its cost management. The other component, asset turnover, illustrates how much revenue 8299 can make from its 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 8299’s capital structure is. Since financial leverage can artificially inflate ROE, we need to look at how much debt 8299 currently has. At 134.33%, 8299’s debt-to-equity ratio appears balanced and indicates its ROE is generated from its capacity to increase profit without a large debt burden.
What this means for you:
Are you a shareholder? 8299 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 8299 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%.