Pizu Group Holdings Limited (SEHK:8053) delivered an ROE of 48.89% over the past 12 months, which is an impressive feat relative to its industry average of 7.90% during the same period. On the surface, this looks fantastic since we know that 8053 has made large profits from little equity capital; however, ROE doesn’t tell us if management have borrowed heavily to make this happen. In this article, we’ll closely examine some factors like financial leverage to evaluate the sustainability of 8053’s ROE. See our latest analysis for Pizu Group Holdings

What you must know about ROE

Return on Equity (ROE) is a measure of Pizu Group Holdings’s profit relative to its shareholders’ equity. An ROE of 48.89% implies HK$0.49 returned on every HK$1 invested. 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 measured against cost of equity in order to determine the efficiency of Pizu Group Holdings’s equity capital deployed. Its cost of equity is 9.66%. Given a positive discrepancy of 39.22% between return and cost, this indicates that Pizu Group Holdings 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 Pizu Group Holdings can generate with its current 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 Pizu Group Holdings’s historic debt-to-equity ratio. The debt-to-equity ratio currently stands at a low 46.29%, meaning the above-average ROE is due to its capacity to produce profit growth without a huge debt burden.

Next Steps:

ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. Pizu Group Holdings exhibits a strong ROE against its peers, as well as sufficient returns to cover its cost of equity. Its high ROE is not likely to be driven by high debt. Therefore, investors may have more confidence in the sustainability of this level of returns going forward. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.

For Pizu Group Holdings, I’ve compiled three essential aspects you should further examine:

1. Financial Health: Does it have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.

2. Management:Have insiders been ramping up their shares to take advantage of the market’s sentiment for Pizu Group Holdings’s future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.

3. Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Pizu Group Holdings? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!

To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned.