This article is intended for those of you who are at the beginning of your investing journey and want a simplistic look at the return on China Best Group Holding Limited (HKG:370) stock.
China Best Group Holding Limited (HKG:370) generated a below-average return on equity of 2.26% in the past 12 months, while its industry returned 7.26%. An investor may attribute an inferior ROE to a relatively inefficient performance, and whilst this can often be the case, knowing the nuts and bolts of the ROE calculation may change that perspective and give you a deeper insight into 370’s past performance. I will take you through how metrics such as financial leverage impact ROE which may affect the overall sustainability of 370’s returns. Check out our latest analysis for China Best Group Holding
Breaking down Return on Equity
Return on Equity (ROE) weighs China Best Group Holding’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$0.023 in earnings from this. If investors diversify their portfolio by industry, they may want to maximise their return in the Distributors sector by investing in 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. China Best Group Holding’s cost of equity is 10.44%. This means China Best Group Holding’s returns actually do not cover its own cost of equity, with a discrepancy of -8.18%. This isn’t sustainable as it implies, very simply, that the company 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
Essentially, profit margin shows how much money the company makes after paying for all its expenses. Asset turnover shows how much revenue China Best Group Holding can generate with its current 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. We can determine if China Best Group Holding’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 China Best Group Holding’s debt-to-equity ratio. Currently, China Best Group Holding has no debt which means its returns are driven purely by equity capital. This could explain why China Best Group Holding’s’ ROE is lower than its industry peers, most of which may have some degree of debt in its business.
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. China Best Group Holding exhibits a weak ROE against its peers, as well as insufficient levels to cover its own cost of equity this year. 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 China Best Group Holding, there are three fundamental 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 China Best Group Holding’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 China Best Group 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!