In This Article:
The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and looking to gauge the potential return on investment in China Renewable Energy Investment Limited (HKG:987).
China Renewable Energy Investment Limited’s (HKG:987) most recent return on equity was a substandard 3.50% relative to its industry performance of 6.87% over the past year. An investor may attribute an inferior ROE to a relatively inefficient performance, and whilst this can often be the case, knowing the nuts and bolts of the ROE calculation may change that perspective and give you a deeper insight into 987’s past performance. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of 987’s returns. Let me show you what I mean by this. Check out our latest analysis for China Renewable Energy Investment
Breaking down Return on Equity
Firstly, Return on Equity, or ROE, is simply the percentage of last years’ earning against the book value of shareholders’ equity. It essentially shows how much the company can generate in earnings given the amount of equity it has raised. In most cases, a higher ROE is preferred; however, there are many other factors we must consider prior to making any investment decisions.
Return on Equity = Net Profit ÷ Shareholders Equity
ROE is measured against cost of equity in order to determine the efficiency of China Renewable Energy Investment’s equity capital deployed. Its cost of equity is 8.44%. Given a discrepancy of -4.94% between return and cost, this indicated that China Renewable Energy Investment may be paying more for its capital than what it’s generating in return. 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
Basically, profit margin measures how much of revenue trickles down into earnings which illustrates how efficient the business is with its cost management. The other component, asset turnover, illustrates how much revenue China Renewable Energy Investment can make from its 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 China Renewable Energy Investment currently has. Currently the debt-to-equity ratio stands at a low 38.23%, which means China Renewable Energy Investment still has headroom to take on more leverage in order to increase profits.