Tianli Holdings Group Limited (SEHK:117) delivered an ROE of 15.72% over the past 12 months, which is an impressive feat relative to its industry average of 10.94% during the same period. While the impressive ratio tells us that 117 has made significant profits from little equity capital, ROE doesn’t tell us if 117 has borrowed debt to make this happen. In this article, we’ll closely examine some factors like financial leverage to evaluate the sustainability of 117’s ROE. Check out our latest analysis for Tianli Holdings Group
Breaking down Return on Equity
Return on Equity (ROE) is a measure of Tianli Holdings Group’s profit relative to its shareholders’ equity. For example, if the company invests HK$1 in the form of equity, it will generate HK$0.16 in earnings from this. 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 Tianli Holdings Group, which is 15.36%. Given a positive discrepancy of 0.36% between return and cost, this indicates that Tianli Holdings Group pays less for its capital than what it generates in return, which is a sign of capital efficiency. 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
Essentially, profit margin shows how much money the company makes after paying for all its expenses. Asset turnover reveals how much revenue can be generated from Tianli Holdings Group’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 financial leverage can artificially inflate ROE, we need to look at how much debt Tianli Holdings Group currently has. At 108.18%, Tianli Holdings Group’s debt-to-equity ratio appears balanced and indicates the above-average ROE is generated from its capacity to increase profit without a large debt burden.