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CBANNER INTERNATIONAL Holdings Limited’s (SEHK:1028) most recent return on equity was a substandard 0.80% relative to its industry performance of 9.41% over the past year. 1028’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 1028’s performance. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of 1028’s returns. Let me show you what I mean by this. View our latest analysis for C.BANNER INTERNATIONAL Holdings
Breaking down ROE — the mother of all ratios
Return on Equity (ROE) is a measure of C.BANNER INTERNATIONAL Holdings’s profit relative to its shareholders’ equity. An ROE of 0.80% implies HK$0.01 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
Returns are usually compared to costs to measure the efficiency of capital. C.BANNER INTERNATIONAL Holdings’s cost of equity is 8.38%. Since C.BANNER INTERNATIONAL Holdings’s return does not cover its cost, with a difference of -7.58%, this means its current use of equity is not efficient and not sustainable. Very simply, C.BANNER INTERNATIONAL Holdings pays more for its capital than what it generates 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
Essentially, profit margin shows how much money the company makes after paying for all its expenses. Asset turnover shows how much revenue C.BANNER INTERNATIONAL Holdings 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 the company’s capital structure is. Since ROE can be inflated by excessive debt, we need to examine C.BANNER INTERNATIONAL Holdings’s debt-to-equity level. Currently the debt-to-equity ratio stands at a reasonable 55.43%, which means its ROE is driven by its ability to grow its profit without a significant debt burden.