This analysis is intended to introduce important early concepts to people who are starting to invest and want to begin learning the link between company’s fundamentals and stock market performance.
EC World Real Estate Investment Trust (SGX:BWCU) outperformed the Industrial REITs industry on the basis of its ROE – producing a higher 7.3% relative to the peer average of 6.6% over the past 12 months. On the surface, this looks fantastic since we know that BWCU has made large profits from little equity capital; however, ROE doesn’t tell us if management have borrowed heavily to make this happen. We’ll take a closer look today at factors like financial leverage to determine whether BWCU’s ROE is actually sustainable.
Check out our latest analysis for EC World Real Estate Investment Trust
Peeling the layers of ROE – trisecting a company’s profitability
Return on Equity (ROE) is a measure of EC World Real Estate Investment Trust’s profit relative to its shareholders’ equity. It essentially shows how much the company 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
Returns are usually compared to costs to measure the efficiency of capital. EC World Real Estate Investment Trust’s cost of equity is 8.5%. Given a discrepancy of -1.2% between return and cost, this indicated that EC World Real Estate Investment Trust 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
The first component is profit margin, which measures how much of sales is retained after the company pays for all its expenses. The other component, asset turnover, illustrates how much revenue EC World Real Estate Investment Trust can make from its 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 EC World Real Estate Investment Trust’s debt-to-equity level. Currently the debt-to-equity ratio stands at a reasonable 61.8%, which means its above-average ROE is driven by its ability to grow its profit without a significant debt burden.