Asian Pay Television Trust’s (SGX:S7OU) most recent return on equity was a substandard 3.09% relative to its industry performance of 12.14% over the past year. 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 S7OU’s past performance. I will take you through how metrics such as financial leverage impact ROE which may affect the overall sustainability of S7OU’s returns. See our latest analysis for Asian Pay Television Trust
Breaking down Return on Equity
Return on Equity (ROE) is a measure of Asian Pay Television Trust’s profit relative to its shareholders’ equity. For example, if the company invests SGD1 in the form of equity, it will generate SGD0.03 in earnings from this. 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 assessed against cost of equity, which is measured using the Capital Asset Pricing Model (CAPM) – but let’s not dive into the details of that today. For now, let’s just look at the cost of equity number for Asian Pay Television Trust, which is 18.12%. This means Asian Pay Television Trust’s returns actually do not cover its own cost of equity, with a discrepancy of -15.03%. This isn’t sustainable as it implies, very simply, that the company pays more for its capital than what it generates in return. ROE can be dissected into three distinct 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 Asian Pay Television Trust’s asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. Since ROE can be artificially increased through excessive borrowing, we should check Asian Pay Television Trust’s historic debt-to-equity ratio. At 117.35%, Asian Pay Television Trust’s debt-to-equity ratio appears balanced and indicates its ROE is generated from its capacity to increase profit without a large debt burden.