What You Must Know About icentury Holding Limited’s (HKG:8507) ROE

This analysis is intended to introduce important early concepts to people who are starting to invest and looking to gauge the potential return on investment in icentury Holding Limited (HKG:8507).

icentury Holding Limited (HKG:8507) delivered an ROE of 13.28% over the past 12 months, which is an impressive feat relative to its industry average of 9.84% during the same period. However, whether this above-industry ROE is actually impressive depends on if it can be maintained. A measure of sustainable returns is 8507’s financial leverage. If 8507 borrows debt to invest in its business, its profits will be higher. But ROE does not capture any debt, so we only see high profits and low equity, which is great on the surface. But today let’s take a deeper dive below this surface. See our latest analysis for i.century Holding

Breaking down ROE — the mother of all ratios

Return on Equity (ROE) weighs i.century Holding’s profit against the level of its 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 Apparel, Accessories and Luxury Goods 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. i.century Holding’s cost of equity is 8.44%. This means i.century Holding returns enough to cover its own cost of equity, with a buffer of 4.84%. 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

SEHK:8507 Last Perf July 5th 18
SEHK:8507 Last Perf July 5th 18

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 i.century Holding 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. ROE can be inflated by disproportionately high levels of debt. This is also unsustainable due to the high interest cost that the company will also incur. Thus, we should look at i.century Holding’s debt-to-equity ratio to examine sustainability of its returns. The most recent ratio is 42.13%, which is sensible and indicates i.century Holding has not taken on too much leverage. Thus, we can conclude its above-average ROE is generated from its capacity to increase profit without a large debt burden.

SEHK:8507 Historical Debt July 5th 18
SEHK:8507 Historical Debt July 5th 18

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. i.century Holding’s above-industry ROE is encouraging, and is also in excess of its cost of equity. ROE is not likely to be inflated by excessive debt funding, giving shareholders more conviction in the sustainability of high returns. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.

For i.century Holding, I’ve put together three key aspects you should look at:

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