This analysis is intended to introduce important early concepts to people who are starting to invest and want to better understand how you can grow your money by investing in Tianjin Tianbao Energy Co Ltd (HKG:1671).
Tianjin Tianbao Energy Co Ltd (HKG:1671) delivered an ROE of 12.37% over the past 12 months, which is relatively in-line with its industry average of 9.89% during the same period. 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, 1671 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 Tianjin Tianbao Energy
Breaking down ROE — the mother of all ratios
Return on Equity (ROE) is a measure of Tianjin Tianbao Energy’s profit relative to its shareholders’ equity. An ROE of 12.37% implies HK$0.12 returned on every HK$1 invested, so the higher the return, the better. If investors diversify their portfolio by industry, they may want to maximise their return in the Electric Utilities 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 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 Tianjin Tianbao Energy, which is 8.44%. This means Tianjin Tianbao Energy returns enough to cover its own cost of equity, with a buffer of 3.93%. This sustainable practice implies that the company pays less 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 Tianjin Tianbao Energy can generate with its current asset base. Finally, financial leverage will be our main focus today. It shows how much of assets are funded by equity and can show how sustainable the company’s capital structure is. We can determine if Tianjin Tianbao Energy’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 Tianjin Tianbao Energy’s debt-to-equity ratio. Currently, Tianjin Tianbao Energy has no debt which means its returns are driven purely by equity capital. Therefore, the level of financial leverage has no impact on ROE, and the ratio is a representative measure of the efficiency of all its capital employed firm-wide.
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. Tianjin Tianbao Energy’s ROE is impressive relative to the industry average and also covers 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. Although ROE can be a useful metric, it is only a small part of diligent research.
For Tianjin Tianbao Energy, I’ve put together three important 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.
- Valuation: What is Tianjin Tianbao Energy 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 Tianjin Tianbao Energy is currently mispriced by the market.
- Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Tianjin Tianbao Energy? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!