The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to begin learning the link between Chengdu PUTIAN Telecommunications Cable Company Limited (HKG:1202)’s return fundamentals and stock market performance.
Chengdu PUTIAN Telecommunications Cable Company Limited (HKG:1202) delivered a less impressive 6.39% ROE over the past year, compared to the 10.06% return generated by its industry. 1202’s results could indicate a relatively inefficient operation to its peers, and while this may be the case, it is important to understand what ROE is made up of and how it should be interpreted. Knowing these components could change your view on 1202’s performance. I will take you through how metrics such as financial leverage impact ROE which may affect the overall sustainability of 1202’s returns. View out our latest analysis for Chengdu PUTIAN Telecommunications Cable
Breaking down Return on Equity
Return on Equity (ROE) weighs Chengdu PUTIAN Telecommunications Cable’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 that are diversifying their portfolio based on industry may want to maximise their return in the Communications Equipment sector by choosing 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
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 Chengdu PUTIAN Telecommunications Cable, which is 11.74%. Given a discrepancy of -5.36% between return and cost, this indicated that Chengdu PUTIAN Telecommunications Cable may be paying more for its capital than what it’s generating in return. ROE can be broken down into three different 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
The first component is profit margin, which measures how much of sales is retained after the company pays for all its expenses. Asset turnover shows how much revenue Chengdu PUTIAN Telecommunications Cable 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 assess whether Chengdu PUTIAN Telecommunications Cable is fuelling ROE by excessively raising debt. Ideally, Chengdu PUTIAN Telecommunications Cable should have a balanced capital structure, which we can check by looking at the historic debt-to-equity ratio of the company. Currently the ratio stands at 10.32%, which is very low. This means Chengdu PUTIAN Telecommunications Cable has not taken on leverage, which could explain its below-average ROE. Chengdu PUTIAN Telecommunications Cable still has headroom to take on more leverage in order to grow its returns.
Next Steps:
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. Chengdu PUTIAN Telecommunications Cable exhibits a weak ROE against its peers, as well as insufficient levels to cover its own cost of equity this year. Although, its appropriate level of leverage means investors can be more confident in the sustainability of Chengdu PUTIAN Telecommunications Cable’s return with a possible increase should the company decide to increase its debt levels. Although ROE can be a useful metric, it is only a small part of diligent research.
For Chengdu PUTIAN Telecommunications Cable, there are 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.
- Valuation: What is Chengdu PUTIAN Telecommunications Cable 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 Chengdu PUTIAN Telecommunications Cable is currently mispriced by the market.
- Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Chengdu PUTIAN Telecommunications Cable? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!