This analysis is intended to introduce important early concepts to people who are starting to invest and want to begin learning the link between company’s fundamentals and stock market performance.
Asian Pay Television Trust (SGX:S7OU) delivered a less impressive 2.18% ROE over the past year, compared to the 9.41% return generated by its industry. 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. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of S7OU’s returns. Let me show you what I mean by this. Check out our latest analysis for Asian Pay Television Trust
Breaking down Return on Equity
Firstly, Return on Equity, or ROE, is simply the percentage of last years’ earning against the book value of shareholders’ equity. An ROE of 2.18% implies SGD0.022 returned on every SGD1 invested, so the higher the return, the better. 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. 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 Asian Pay Television Trust’s equity capital deployed. Its cost of equity is 17.44%. This means Asian Pay Television Trust’s returns actually do not cover its own cost of equity, with a discrepancy of -15.26%. This isn’t sustainable as it implies, very simply, that the company 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
The first component is profit margin, which measures how much of sales is retained after the company pays for all its expenses. The other component, asset turnover, illustrates how much revenue Asian Pay Television Trust can make from its 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 Asian Pay Television Trust’s debt-to-equity ratio to examine sustainability of its returns. Currently the ratio stands at 122.34%, which is relatively balanced. This means Asian Pay Television Trust has not taken on excessive leverage, and its current ROE is driven by its ability to grow its profit without a significant debt burden.
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality 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. Although, its appropriate level of leverage means investors can be more confident in the sustainability of Asian Pay Television Trust’s return with a possible increase should the company decide to increase its debt levels. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.
For Asian Pay Television Trust, there are three pertinent factors you should look at:
- 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 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.
- 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!