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 Red Star Macalline Group Corporation Ltd (HKG:1528).
Red Star Macalline Group Corporation Ltd (HKG:1528) performed in-line with its real estate operating companies industry on the basis of its ROE – producing a return of9.52% relative to the peer average of 9.26% over the past 12 months. However, whether this 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, 1528 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. Check out our latest analysis for Red Star Macalline Group
Breaking down Return on Equity
Return on Equity (ROE) weighs Red Star Macalline Group’s profit against the level of its shareholders’ equity. An ROE of 9.52% implies HK$0.095 returned on every HK$1 invested, so the higher the return, the better. Investors that are diversifying their portfolio based on industry may want to maximise their return in the Real Estate Operating Companies sector by choosing 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 measured against cost of equity in order to determine the efficiency of Red Star Macalline Group’s equity capital deployed. Its cost of equity is 10.97%. Since Red Star Macalline Group’s return does not cover its cost, with a difference of -1.46%, this means its current use of equity is not efficient and not sustainable. Very simply, Red Star Macalline Group pays more 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
The first component is profit margin, which measures how much of sales is retained after the company pays for all its expenses. The other component, asset turnover, illustrates how much revenue Red Star Macalline Group 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 Red Star Macalline Group’s debt-to-equity ratio to examine sustainability of its returns. The ratio currently stands at a sensible 62.28%, meaning Red Star Macalline Group 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. Red Star Macalline Group’s ROE is impressive relative to the industry average, though its returns were not strong enough to cover its own 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. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.
For Red Star Macalline Group, I’ve compiled three pertinent factors you should further examine:
- 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 Red Star Macalline Group’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 Red Star Macalline 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!