Asian Pay Television Trust (SGX:S7OU) generated a below-average return on equity of 3.09% in the past 12 months, while its industry returned 11.43%. S7OU’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 S7OU’s performance. I will take you through how metrics such as financial leverage impact ROE which may affect the overall sustainability of S7OU’s returns. Check out our latest analysis for Asian Pay Television Trust
Breaking down Return on Equity
Return on Equity (ROE) is a measure of Asian Pay Television Trust’s profit relative to its shareholders’ equity. For example, if the company invests SGD1 in the form of equity, it will generate SGD0.03 in earnings from this. If investors diversify their portfolio by industry, they may want to maximise their return in the Cable and Satellite sector by investing in the highest returning stock. However, this can be deceiving as each company has varying costs of equity and debt levels, which could exaggeratedly push up ROE at the same time as 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 Asian Pay Television Trust, which is 18.12%. Since Asian Pay Television Trust’s return does not cover its cost, with a difference of -15.03%, this means its current use of equity is not efficient and not sustainable. Very simply, Asian Pay Television Trust pays more for its capital than what it generates in return. ROE can be dissected into three distinct 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 Asian Pay Television Trust can generate with its current asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. We can determine if Asian Pay Television Trust’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 Asian Pay Television Trust’s debt-to-equity ratio. The ratio currently stands at a balanced 117.35%, meaning Asian Pay Television Trust has not taken on excessively disproportionate debt to drive its returns. The company is able to produce profit growth without a substantial 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. Asian Pay Television Trust’s below-industry ROE is disappointing, furthermore, its returns were not even high enough to cover its own cost of equity. 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 Asian Pay Television Trust, I’ve compiled three important aspects you should look at:
- 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 Asian Pay Television Trust 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 Asian Pay Television Trust is currently mispriced by the market.
- 3. Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Asian Pay Television Trust? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!