How Did Singapore Technologies Engineering Ltd's (SGX:S63) 21.02% ROE Fare Against The Industry?

Singapore Technologies Engineering Ltd (SGX:S63) outperformed the aerospace and defense industry on the basis of its ROE – producing a higher 21.02% relative to the peer average of 14.31% over the past 12 months. However, whether this above-industry ROE is actually impressive depends on if it can be maintained. A measure of sustainable returns is S63’s financial leverage. If S63 borrows debt to invest in its business, its profits will be higher. But ROE does not capture any debt, so we only see high profits and low equity, which is great on the surface. But today let’s take a deeper dive below this surface. Check out our latest analysis for Singapore Technologies Engineering

Breaking down ROE — the mother of all ratios

Return on Equity (ROE) is a measure of Singapore Technologies Engineering’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. Investors that are diversifying their portfolio based on industry may want to maximise their return in the Aerospace and Defense sector by choosing the highest returning stock. However, this can be misleading as each firm has different costs of equity and debt levels i.e. the more debt Singapore Technologies Engineering has, the higher ROE is pumped up in the short term, at the expense of long term interest payment burden.

ROE is measured against cost of equity in order to determine the efficiency of Singapore Technologies Engineering’s equity capital deployed. Its cost of equity is 9.17%. This means Singapore Technologies Engineering returns enough to cover its own cost of equity, with a buffer of 11.85%. 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:

Essentially, profit margin shows how much money the company makes after paying for all its expenses. Asset turnover shows how much revenue Singapore Technologies Engineering 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. 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 Singapore Technologies Engineering’s debt-to-equity ratio to examine sustainability of its returns. The most recent ratio is 39.85%, which is sensible and indicates Singapore Technologies Engineering has not taken on too much leverage. Thus, we can conclude its above-average ROE is generated from its capacity to increase profit without a large debt burden.

Next Steps:

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. Singapore Technologies Engineering’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 Singapore Technologies Engineering, there are three essential aspects you should further examine:

1. 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.
2. Valuation: What is Singapore Technologies Engineering 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 Singapore Technologies Engineering is currently mispriced by the market.
3. Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Singapore Technologies Engineering? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!

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Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.