With an ROE of 25.49%, C-MER Eye Care Holdings Limited (SEHK:3309) outpaced its own industry which delivered a less exciting 9.33% over the past year. However, whether this above-industry ROE is actually impressive depends on if it can be maintained. This can be measured by looking at the company’s financial leverage. With more debt, 3309 can invest even more and earn more money, thus pushing up its returns. However, ROE only measures returns against equity, not debt. This can be distorted, so let’s take a look at it further. See our latest analysis for C-MER Eye Care Holdings
What you must know about ROE
Return on Equity (ROE) weighs C-MER Eye Care Holdings’s profit against the level of its shareholders’ equity. For example, if the company invests HK$1 in the form of equity, it will generate HK$0.25 in earnings from this. If investors diversify their portfolio by industry, they may want to maximise their return in the Healthcare Services sector by investing in 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 C-MER Eye Care Holdings, which is 4.96%. Since C-MER Eye Care Holdings’s return covers its cost in excess of 20.53%, its use of equity capital is efficient and likely to be sustainable. Simply put, C-MER Eye Care Holdings pays less for its capital than what it generates in return. ROE can be dissected into three distinct 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
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 C-MER Eye Care Holdings can make from its asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. 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 C-MER Eye Care Holdings’s debt-to-equity ratio to examine sustainability of its returns. The ratio currently stands at a sensible 5.68%, meaning C-MER Eye Care Holdings has not taken on excessive debt to drive its returns. The company is able to produce profit growth without a huge debt burden.
ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. C-MER Eye Care Holdings’s ROE is impressive relative to the industry average and also covers its cost of equity. Its high ROE is not likely to be driven by high debt. Therefore, investors may have more confidence in the sustainability of this level of returns going forward. Although ROE can be a useful metric, it is only a small part of diligent research.
For C-MER Eye Care Holdings, I’ve compiled three key aspects you should look at:
- 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.
- Valuation: What is C-MER Eye Care Holdings 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 C-MER Eye Care Holdings is currently mispriced by the market.
- Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of C-MER Eye Care 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!