I am writing today to help inform people who are new to the stock market and want to better understand how you can grow your money by investing in CapitaLand Limited (SGX:C31).
With an ROE of 7.19%, CapitaLand Limited (SGX:C31) returned in-line to its own industry which delivered 6.62% over the past year. But what is more interesting is whether C31 can sustain this level of return. This can be measured by looking at the company’s financial leverage. With more debt, C31 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. View out our latest analysis for CapitaLand
What you must know about ROE
Return on Equity (ROE) is a measure of CapitaLand’s profit relative to its shareholders’ equity. For example, if the company invests SGD1 in the form of equity, it will generate SGD0.072 in earnings from this. If investors diversify their portfolio by industry, they may want to maximise their return in the Diversified Real Estate Activities 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
Returns are usually compared to costs to measure the efficiency of capital. CapitaLand’s cost of equity is 10.37%. Given a discrepancy of -3.18% between return and cost, this indicated that CapitaLand may be paying more for its capital than what it’s generating in return. ROE can be dissected into three distinct ratios: net profit margin, asset turnover, and financial leverage. This is called the Dupont Formula:
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 reveals how much revenue can be generated from CapitaLand’s asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. We can determine if CapitaLand’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 CapitaLand’s debt-to-equity ratio. The ratio currently stands at a sensible 66.47%, meaning CapitaLand has not taken on excessive debt to drive its returns. The company is able to produce profit growth without a huge 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. CapitaLand’s ROE is impressive relative to the industry average, though its returns were not strong enough to cover its own cost of equity. ROE is not likely to be inflated by excessive debt funding, giving shareholders more conviction in the sustainability of industry-beating returns. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.
For CapitaLand, I’ve compiled three important 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.
- Management:Have insiders been ramping up their shares to take advantage of the market’s sentiment for CapitaLand’s future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
- Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of CapitaLand? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!