Wuxi Sunlit Science and Technology Company Limited (HKG:1289): Can It Deliver A Superior ROE To The Industry?

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Wuxi Sunlit Science and Technology Company Limited (SEHK:1289) delivered a less impressive 6.38% ROE over the past year, compared to the 10.00% return generated by its industry. 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 1289’s past performance. I will take you through how metrics such as financial leverage impact ROE which may affect the overall sustainability of 1289’s returns. Check out our latest analysis for Wuxi Sunlit Science and Technology

What you must know about ROE

Return on Equity (ROE) is a measure of Wuxi Sunlit Science and Technology’s profit relative to its shareholders’ equity. For example, if the company invests HK$1 in the form of equity, it will generate HK$0.06 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

Returns are usually compared to costs to measure the efficiency of capital. Wuxi Sunlit Science and Technology’s cost of equity is 10.74%. This means Wuxi Sunlit Science and Technology’s returns actually do not cover its own cost of equity, with a discrepancy of -4.36%. This isn’t sustainable as it implies, very simply, that the company pays more 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

SEHK:1289 Last Perf Feb 14th 18
SEHK:1289 Last Perf Feb 14th 18

Essentially, profit margin shows how much money the company makes after paying for all its expenses. The other component, asset turnover, illustrates how much revenue Wuxi Sunlit Science and Technology 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 Wuxi Sunlit Science and Technology currently has. Currently, Wuxi Sunlit Science and Technology has no debt which means its returns are driven purely by equity capital. This could explain why Wuxi Sunlit Science and Technology’s’ ROE is lower than its industry peers, most of which may have some degree of debt in its business.