I am writing today to help inform people who are new to the stock market and want to better understand how you can grow your money by investing in APAC Realty Limited (SGX:CLN).

APAC Realty Limited (SGX:CLN) outperformed the Real Estate Services industry on the basis of its ROE – producing a higher 20.00% relative to the peer average of 6.62% over the past 12 months. While the impressive ratio tells us that CLN has made significant profits from little equity capital, ROE doesn’t tell us if CLN has borrowed debt to make this happen. We’ll take a closer look today at factors like financial leverage to determine whether CLN’s ROE is actually sustainable. Check out our latest analysis for APAC Realty

Peeling the layers of ROE – trisecting a company’s profitability

Return on Equity (ROE) weighs APAC Realty’s profit against the level of its shareholders’ equity. For example, if the company invests SGD1 in the form of equity, it will generate SGD0.20 in earnings from this. 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 APAC Realty’s equity capital deployed. Its cost of equity is 8.51%. Given a positive discrepancy of 11.49% between return and cost, this indicates that APAC Realty pays less for its capital than what it generates in return, which is a sign of capital efficiency. 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 shows how much revenue APAC Realty can generate with its current 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 financial leverage can artificially inflate ROE, we need to look at how much debt APAC Realty currently has. Currently, APAC Realty has no debt which means its returns are driven purely by equity capital. Therefore, the level of financial leverage has no impact on ROE, and the ratio is a representative measure of the efficiency of all its capital employed firm-wide.