Frasers Logistics & Industrial Trust (SGX:BUOU) outperformed the Industrial REITs industry on the basis of its ROE – producing a higher 7.71% relative to the peer average of 7.25% over the past 12 months. Superficially, this looks great since we know that BUOU has generated big profits with little equity capital; however, ROE doesn’t tell us how much BUOU has borrowed in debt. In this article, we’ll closely examine some factors like financial leverage to evaluate the sustainability of BUOU’s ROE. Check out our latest analysis for Frasers Logistics & Industrial Trust
What you must know about ROE
Return on Equity (ROE) weighs Frasers Logistics & Industrial Trust’s profit against the level of its shareholders’ equity. For example, if the company invests SGD1 in the form of equity, it will generate SGD0.08 in earnings from this. 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
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 Frasers Logistics & Industrial Trust, which is 8.38%. This means Frasers Logistics & Industrial Trust’s returns actually do not cover its own cost of equity, with a discrepancy of -0.67%. 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. The other component, asset turnover, illustrates how much revenue Frasers Logistics & Industrial 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 artificially increased through excessive borrowing, we should check Frasers Logistics & Industrial Trust’s historic debt-to-equity ratio. At 45.43%, Frasers Logistics & Industrial Trust’s debt-to-equity ratio appears low and indicates the above-average ROE is generated from its capacity to increase profit without a large debt burden.