Why LEAP Holdings Group Limited (HKG:1499) Delivered An Inferior ROE Compared To The Industry

This article is intended for those of you who are at the beginning of your investing journey and want to better understand how you can grow your money by investing in LEAP Holdings Group Limited (HKG:1499).

LEAP Holdings Group Limited (HKG:1499) delivered an ROE of 11.08% over the past 12 months, which is relatively in-line with its industry average of 11.59% during the same period. But what is more interesting is whether 1499 can sustain or improve on this level of return. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of 1499’s returns. Let me show you what I mean by this. View out our latest analysis for LEAP Holdings Group

What you must know about ROE

Return on Equity (ROE) is a measure of LEAP Holdings Group’s profit relative to its shareholders’ equity. An ROE of 11.08% implies HK$0.11 returned on every HK$1 invested, so the higher the return, the better. Investors seeking to maximise their return in the Construction and Engineering industry may want to choose the highest returning stock. However, this can be deceiving as each company has varying costs of equity and debt levels, which could exaggeratedly push up ROE at the same time as accumulating high interest expense.

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 LEAP Holdings Group, which is 8.44%. LEAP Holdings Group’s ROE exceeds its cost by 2.64%, which is a big tick. Some of its peers with higher ROE may face a cost which exceeds returns, which is unsustainable and far less desirable than LEAP Holdings Group’s case of positive discrepancy. 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

SEHK:1499 Last Perf June 25th 18
SEHK:1499 Last Perf June 25th 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 LEAP Holdings Group can make from its 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. We can determine if LEAP Holdings Group’s ROE is inflated by borrowing high levels of debt. Generally, a balanced capital structure means its returns will be sustainable over the long run. We can examine this by looking at LEAP Holdings Group’s debt-to-equity ratio. The most recent ratio is 2.13%, which is sensible and indicates LEAP Holdings Group has not taken on too much leverage. Thus, we can conclude its below-average ROE may be a result of low debt, and LEAP Holdings Group still has room to increase leverage and grow future returns.

SEHK:1499 Historical Debt June 25th 18
SEHK:1499 Historical Debt June 25th 18

Next Steps:

ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. Although LEAP Holdings Group’s ROE is underwhelming relative to the industry average, its returns are high enough to cover the cost of equity. Its appropriate level of leverage means investors can be more confident in the sustainability of LEAP Holdings Group’s return with a possible increase should the company decide to increase its debt levels. Although ROE can be a useful metric, it is only a small part of diligent research.

For LEAP Holdings Group, I’ve compiled three fundamental aspects you should further research:

  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 LEAP Holdings Group 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 LEAP Holdings Group is currently mispriced by the market.
  3. Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of LEAP Holdings Group? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!