With an ROE of 4.27%, Suntec Real Estate Investment Trust (SGX:T82U) returned in-line to its own industry which delivered 7.25% over the past year. But what is more interesting is whether T82U can sustain or improve on this level of return. I will take you through how metrics such as financial leverage impact ROE which may affect the overall sustainability of T82U’s returns. Check out our latest analysis for Suntec Real Estate Investment Trust
Peeling the layers of ROE – trisecting a company’s profitability
Return on Equity (ROE) is a measure of Suntec Real Estate Investment Trust’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 Diversified REITs sector by choosing 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. Suntec Real Estate Investment Trust’s cost of equity is 6.62%. Since Suntec Real Estate Investment Trust’s return does not cover its cost, with a difference of -2.36%, this means its current use of equity is not efficient and not sustainable. Very simply, Suntec Real Estate Investment Trust pays more 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
The first component is profit margin, which measures how much of sales is retained after the company pays for all its expenses. Asset turnover reveals how much revenue can be generated from Suntec Real Estate Investment Trust’s asset base. And finally, financial leverage is simply how much of assets are funded by equity, which exhibits how sustainable the company’s capital structure is. We can determine if Suntec Real Estate Investment 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 Suntec Real Estate Investment Trust’s debt-to-equity ratio. The most recent ratio is 56.38%, which is sensible and indicates Suntec Real Estate Investment Trust has not taken on too much leverage. Thus, we can conclude its current ROE is generated from its capacity to increase profit without a large debt burden.
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. Suntec Real Estate Investment 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 Suntec Real Estate Investment Trust’s return with a possible increase should the company decide to increase its debt levels. Although ROE can be a useful metric, it is only a small part of diligent research.
For Suntec Real Estate Investment Trust, there are three essential 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.
- Valuation: What is Suntec Real Estate Investment 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 Suntec Real Estate Investment Trust is currently mispriced by the market.
- Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Suntec Real Estate Investment 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!