Sarine Technologies Ltd (SGX:U77) delivered an ROE of 14.07% over the past 12 months, which is an impressive feat relative to its industry average of 10.74% during the same period. Superficially, this looks great since we know that U77 has generated big profits with little equity capital; however, ROE doesn’t tell us how much U77 has borrowed in debt. In this article, we’ll closely examine some factors like financial leverage to evaluate the sustainability of U77’s ROE. See our latest analysis for Sarine Technologies

What you must know about ROE

Return on Equity (ROE) is a measure of Sarine Technologies’s profit relative to its shareholders’ equity. An ROE of 14.07% implies SGD0.14 returned on every SGD1 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

Returns are usually compared to costs to measure the efficiency of capital. Sarine Technologies’s cost of equity is 8.39%. Given a positive discrepancy of 5.68% between return and cost, this indicates that Sarine Technologies pays less for its capital than what it generates in return, which is a sign of capital efficiency. ROE can be split up into three useful 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. Asset turnover reveals how much revenue can be generated from Sarine Technologies’s 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 Sarine Technologies’s historic debt-to-equity ratio. Currently, Sarine Technologies has no debt which means its returns are driven purely by equity capital. Therefore, the level of financial leverage has no impact on ROE, and the ratio is a representative measure of the efficiency of all its capital employed firm-wide.

What this means for you:

Are you a shareholder? U77’s ROE is impressive relative to the industry average and also covers 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%.