Luxking Group Holdings Limited’s (SGX:BKK) most recent return on equity was a substandard 2.37% relative to its industry performance of 7.13% over the past year. BKK’s results could indicate a relatively inefficient operation to its peers, and while this may be the case, it is important to understand what ROE is made up of and how it should be interpreted. Knowing these components could change your view on BKK’s performance. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of BKK’s returns. Let me show you what I mean by this. Check out our latest analysis for Luxking Group Holdings
Breaking down ROE — the mother of all ratios
Return on Equity (ROE) is a measure of Luxking Group Holdings’s profit relative to its shareholders’ equity. An ROE of 2.37% implies SGD0.02 returned on every SGD1 invested. 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 measured against cost of equity in order to determine the efficiency of Luxking Group Holdings’s equity capital deployed. Its cost of equity is 18.12%. Since Luxking Group Holdings’s return does not cover its cost, with a difference of -15.75%, this means its current use of equity is not efficient and not sustainable. Very simply, Luxking Group Holdings 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. Asset turnover reveals how much revenue can be generated from Luxking Group Holdings’s asset base. Finally, financial leverage will be our main focus today. It shows how much of assets are funded by equity and can show how sustainable the company’s capital structure is. Since ROE can be artificially increased through excessive borrowing, we should check Luxking Group Holdings’s historic debt-to-equity ratio. At 79.27%, Luxking Group Holdings’s debt-to-equity ratio appears sensible and indicates its ROE is generated from its capacity to increase profit without a large debt burden.