With an ROE of 35.56%, Q & M Dental Group (Singapore) Limited (SGX:QC7) outpaced its own industry which delivered a less exciting 9.77% over the past year. On the surface, this looks fantastic since we know that QC7 has made large profits from little equity capital; however, ROE doesn’t tell us if management have borrowed heavily to make this happen. Today, we’ll take a closer look at some factors like financial leverage to see how sustainable QC7’s ROE is. See our latest analysis for Q & M Dental Group (Singapore)

Breaking down Return on Equity

Return on Equity (ROE) weighs Q & M Dental Group (Singapore)’s profit against the level of 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. Q & M Dental Group (Singapore)’s cost of equity is 8.38%. This means Q & M Dental Group (Singapore) returns enough to cover its own cost of equity, with a buffer of 27.19%. 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

Essentially, profit margin shows how much money the company makes after paying for all its expenses. The other component, asset turnover, illustrates how much revenue Q & M Dental Group (Singapore) 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 Q & M Dental Group (Singapore)’s historic debt-to-equity ratio. Currently the debt-to-equity ratio stands at a reasonable 75.56%, which means its above-average ROE is driven by its ability to grow its profit without a significant debt burden.

What this means for you:

Are you a shareholder? QC7’s above-industry ROE is encouraging, and is also in excess of its cost of equity. Since its high ROE is not likely driven by high debt, it might be a good time to top up on your current holdings if your fundamental research reaffirms this analysis. If you’re looking for new ideas for high-returning stocks, you should take a look at our free platform to see the list of stocks with Return on Equity over 20%.