The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want a simplistic look at the return on Zhaobangji Properties Holdings Limited (HKG:1660) stock.
With an ROE of 7.45%, Zhaobangji Properties Holdings Limited (HKG:1660) returned in-line to its own industry which delivered 8.15% over the past year. But what is more interesting is whether 1660 can sustain or improve on this level of return. Today I will look at how components such as financial leverage can influence ROE which may impact the sustainability of 1660’s returns. Check out our latest analysis for Zhaobangji Properties Holdings
Breaking down ROE — the mother of all ratios
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. Investors seeking to maximise their return in the Trading Companies and Distributors industry may want to choose the highest returning stock. But this can be misleading as each company has different costs of equity and also varying debt levels, which could artificially push up ROE whilst accumulating high interest expense.
Return on Equity = Net Profit ÷ Shareholders Equity
Returns are usually compared to costs to measure the efficiency of capital. Zhaobangji Properties Holdings’s cost of equity is 9.06%. Since Zhaobangji Properties Holdings’s return does not cover its cost, with a difference of -1.61%, this means its current use of equity is not efficient and not sustainable. Very simply, Zhaobangji Properties Holdings 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:
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. Asset turnover shows how much revenue Zhaobangji Properties Holdings can generate with its current 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 assess whether Zhaobangji Properties Holdings is fuelling ROE by excessively raising debt. Ideally, Zhaobangji Properties Holdings should have a balanced capital structure, which we can check by looking at the historic debt-to-equity ratio of the company. The ratio currently stands at a sensible 25.05%, meaning Zhaobangji Properties Holdings has not taken on excessive debt to drive its returns. The company is able to produce profit growth without a huge debt burden and still has headroom to grow returns to industry average.
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. Zhaobangji Properties Holdings’s ROE is underwhelming relative to the industry average, and its returns were also not strong enough to cover its own cost of equity. However, ROE is not likely to be inflated by excessive debt funding, giving shareholders more conviction in the sustainability of returns, which has headroom to increase further. Although ROE can be a useful metric, it is only a small part of diligent research.
For Zhaobangji Properties Holdings, I’ve compiled three essential aspects you should further research:
- 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.
- Future Earnings: How does Zhaobangji Properties Holdings’s growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
- Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Zhaobangji Properties Holdings? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!