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This analysis is intended to introduce important early concepts to people who are starting to invest and want a simplistic look at the return on Fu Shou Yuan International Group Limited (HKG:1448) stock.
Fu Shou Yuan International Group Limited (HKG:1448) outperformed the Specialized Consumer Services industry on the basis of its ROE – producing a higher 15.26% relative to the peer average of 14.10% over the past 12 months. While the impressive ratio tells us that 1448 has made significant profits from little equity capital, ROE doesn’t tell us if 1448 has borrowed debt to make this happen. In this article, we’ll closely examine some factors like financial leverage to evaluate the sustainability of 1448’s ROE. See our latest analysis for Fu Shou Yuan International Group
Breaking down ROE — the mother of all ratios
Firstly, Return on Equity, or ROE, is simply the percentage of last years’ earning against the book value of shareholders’ equity. For example, if the company invests HK$1 in the form of equity, it will generate HK$0.15 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
Returns are usually compared to costs to measure the efficiency of capital. Fu Shou Yuan International Group’s cost of equity is 12.18%. This means Fu Shou Yuan International Group returns enough to cover its own cost of equity, with a buffer of 3.08%. This sustainable practice implies that the company pays less 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 Fu Shou Yuan International Group can make from its 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 Fu Shou Yuan International Group’s historic debt-to-equity ratio. At 4.57%, Fu Shou Yuan International Group’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.