Southeast Asia Properties & Finance Limited (SEHK:252) generated a below-average return on equity of 8.57% in the past 12 months, while its industry returned 12.03%. An investor may attribute an inferior ROE to a relatively inefficient performance, and whilst this can often be the case, knowing the nuts and bolts of the ROE calculation may change that perspective and give you a deeper insight into 252’s past performance. I will take you through how metrics such as financial leverage impact ROE which may affect the overall sustainability of 252’s returns. View our latest analysis for Southeast Asia Properties & Finance
Breaking down Return on Equity
Return on Equity (ROE) weighs 252’s profit against the level of its shareholders’ equity. It essentially shows how much 252 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
ROE is measured against cost of equity in order to determine the efficiency of 252’s equity capital deployed. Its cost of equity is 11.51%. Given a discrepancy of -2.94% between return and cost, this indicated that 252 may be paying more for its capital than what it’s generating in return. ROE can be broken down into three different 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 252 is with its cost management. Asset turnover shows how much revenue 252 can generate with its current asset base. And finally, financial leverage is simply how much of assets are funded by equity, which exhibits how sustainable 252’s capital structure is. Since ROE can be artificially increased through excessive borrowing, we should check 252’s historic debt-to-equity ratio. The debt-to-equity ratio currently stands at a low 19.33%, meaning 252 still has headroom to borrow debt to increase profits.
What this means for you:
Are you a shareholder? 252’s ROE is underwhelming relative to the industry average, and its returns were also not strong enough to cover its own cost of equity. However, investors shouldn’t despair since ROE is not inflated by excessive debt, which means 252 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%.