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 Camsing International Holding Limited (HKG:2662)’s return fundamentals and stock market performance.
Camsing International Holding Limited (HKG:2662) performed in-line with its electronic components industry on the basis of its ROE – producing a return of11.73% relative to the peer average of 10.89% over the past 12 months. However, whether this ROE is actually impressive depends on if it can be maintained. Sustainability can be gauged by a company’s financial leverage – the more debt it has, the higher ROE is pumped up in the short term, at the expense of long term interest payment burden. Let me show you what I mean by this. See our latest analysis for Camsing International Holding
What you must know about ROE
Return on Equity (ROE) is a measure of Camsing International Holding’s profit relative to its shareholders’ equity. It essentially shows how much the company can generate in earnings given the amount of equity it has raised. If investors diversify their portfolio by industry, they may want to maximise their return in the Electronic Components 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
ROE is measured against cost of equity in order to determine the efficiency of Camsing International Holding’s equity capital deployed. Its cost of equity is 8.44%. Since Camsing International Holding’s return covers its cost in excess of 3.29%, its use of equity capital is efficient and likely to be sustainable. Simply put, Camsing International Holding pays less for its capital than what it generates 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:
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 Camsing International Holding can generate with its current asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. We can assess whether Camsing International Holding is fuelling ROE by excessively raising debt. Ideally, Camsing International Holding 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 9.68%, which is very low. This means Camsing International Holding has not taken on leverage, and its above-average ROE is driven by its ability to grow its profit without a huge debt burden.
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. Camsing International 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 Camsing International Holding, I’ve compiled three key factors 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 Camsing International 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 Camsing International Holding is currently mispriced by the market.
- Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Camsing International 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!