Grand Field Group Holdings Limited (SEHK:115) delivered a less impressive 6.34% ROE over the past year, compared to the 8.41% return generated by its industry. Though 115’s recent performance is underwhelming, it is useful to understand what ROE is made up of and how it should be interpreted. Knowing these components can change your views on 115’s below-average returns. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of 115’s returns. Let me show you what I mean by this. View our latest analysis for Grand Field Group Holdings

Breaking down Return on Equity

Return on Equity (ROE) weighs Grand Field Group Holdings’s profit against the level of its shareholders’ equity. An ROE of 6.34% implies HK$0.06 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 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 Grand Field Group Holdings, which is 10.56%. Given a discrepancy of -4.22% between return and cost, this indicated that Grand Field Group Holdings 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 Grand Field Group Holdings 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 Grand Field Group Holdings’s debt-to-equity level. The debt-to-equity ratio currently stands at a low 10.03%, meaning Grand Field Group Holdings still has headroom to borrow debt to increase profits.

Next Steps:

While ROE is a relatively simple calculation, it can be broken down into different ratios, each telling a different story about the strengths and weaknesses of a company. Grand Field Group Holdings exhibits a weak ROE against its peers, as well as insufficient levels to cover its own cost of equity this year. Although, its appropriate level of leverage means investors can be more confident in the sustainability of Grand Field Group Holdings’s return with a possible increase should the company decide to increase its debt levels. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.