I am writing today to help inform people who are new to the stock market and want to better understand how you can grow your money by investing in Phoenix Media Investment (Holdings) Limited (HKG:2008).

Phoenix Media Investment (Holdings) Limited (HKG:2008) delivered a less impressive 7.12% ROE over the past year, compared to the 8.18% return generated by its industry. 2008’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 2008’s performance. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of 2008’s returns. Let me show you what I mean by this. Check out our latest analysis for Phoenix Media Investment (Holdings)

Breaking down ROE — the mother of all ratios

Return on Equity (ROE) is a measure of Phoenix Media Investment (Holdings)’s profit relative to its shareholders’ equity. It essentially shows how much the company can generate in earnings given the amount of equity it has raised. 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 measured against cost of equity in order to determine the efficiency of Phoenix Media Investment (Holdings)’s equity capital deployed. Its cost of equity is 15.43%. Given a discrepancy of -8.31% between return and cost, this indicated that Phoenix Media Investment (Holdings) may be paying more for its capital than what it’s generating 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

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 Phoenix Media Investment (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 financial leverage can artificially inflate ROE, we need to look at how much debt Phoenix Media Investment (Holdings) currently has. Currently the debt-to-equity ratio stands at a low 16.91%, which means Phoenix Media Investment (Holdings) still has headroom to take on more leverage in order 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. Phoenix Media Investment (Holdings)’s ROE is underwhelming relative to the industry average, and its returns were also not strong enough to cover its own cost of equity. Although, its appropriate level of leverage means investors can be more confident in the sustainability of Phoenix Media Investment (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.

For Phoenix Media Investment (Holdings), there are three essential aspects you should look at:

1. Financial Health: Does it have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.

2. Valuation: What is Phoenix Media Investment (Holdings) worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether Phoenix Media Investment (Holdings) is currently mispriced by the market.

3. Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Phoenix Media Investment (Holdings)? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!

To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned.