In This Article:
I am writing today to help inform people who are new to the stock market and looking to gauge the potential return on investment in Wai Kee Holdings Limited (HKG:610).
Wai Kee Holdings Limited (HKG:610) outperformed the Construction and Engineering industry on the basis of its ROE – producing a higher 13.47% relative to the peer average of 11.59% over the past 12 months. On the surface, this looks fantastic since we know that 610 has made large profits from little equity capital; however, ROE doesn’t tell us if management have borrowed heavily to make this happen. In this article, we’ll closely examine some factors like financial leverage to evaluate the sustainability of 610’s ROE. View out our latest analysis for Wai Kee Holdings
Breaking down Return on Equity
Return on Equity (ROE) weighs Wai Kee Holdings’s profit against the level of its shareholders’ equity. An ROE of 13.47% implies HK$0.13 returned on every HK$1 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. Wai Kee Holdings’s cost of equity is 8.44%. This means Wai Kee Holdings returns enough to cover its own cost of equity, with a buffer of 5.03%. This sustainable practice implies that the company pays less for its capital than what it generates in return. 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. The other component, asset turnover, illustrates how much revenue Wai Kee Holdings can make from its asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. Since ROE can be inflated by excessive debt, we need to examine Wai Kee Holdings’s debt-to-equity level. The debt-to-equity ratio currently stands at a low 15.92%, meaning the above-average ROE is due to its capacity to produce profit growth without a huge debt burden.
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. Wai Kee Holdings’s ROE is impressive relative to the industry average and also covers its cost of equity. Its high ROE is not likely to be driven by high debt. Therefore, investors may have more confidence in the sustainability of this level of returns going forward. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.