What You Must Know About Azeus Systems Holdings Ltd’s (SGX:BBW) Return on Equity

This article is intended for those of you who are at the beginning of your investing journey and looking to gauge the potential return on investment in Azeus Systems Holdings Ltd (SGX:BBW).

Azeus Systems Holdings Ltd (SGX:BBW) generated a below-average return on equity of 2.12% in the past 12 months, while its industry returned 12.96%. An investor may attribute an inferior ROE to a relatively inefficient performance, and whilst this can often be the case, knowing the nuts and bolts of the ROE calculation may change that perspective and give you a deeper insight into BBW’s past performance. Today I will look at how components such as financial leverage can influence ROE which may impact the sustainability of BBW’s returns. Check out our latest analysis for Azeus Systems Holdings

What you must know about ROE

Firstly, Return on Equity, or ROE, is simply the percentage of last years’ earning against the book value of shareholders’ equity. For example, if the company invests SGD1 in the form of equity, it will generate SGD0.021 in earnings from this. Investors that are diversifying their portfolio based on industry may want to maximise their return in the IT Consulting and Other Services 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 Azeus Systems Holdings has, the higher ROE is pumped up in the short term, at the expense of long term interest payment burden.

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 Azeus Systems Holdings, which is 8.51%. Since Azeus Systems Holdings’s return does not cover its cost, with a difference of -6.40%, this means its current use of equity is not efficient and not sustainable. Very simply, Azeus Systems Holdings 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:

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

SGX:BBW Last Perf July 4th 18
SGX:BBW Last Perf July 4th 18

The first component is profit margin, which measures how much of sales is retained after the company pays for all its expenses. Asset turnover shows how much revenue Azeus Systems Holdings 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. We can assess whether Azeus Systems Holdings is fuelling ROE by excessively raising debt. Ideally, Azeus Systems Holdings should have a balanced capital structure, which we can check by looking at the historic debt-to-equity ratio of the company. Currently, Azeus Systems Holdings has no debt which means its returns are driven purely by equity capital. This could explain why Azeus Systems Holdings’s’ ROE is lower than its industry peers, most of which may have some degree of debt in its business.

SGX:BBW Historical Debt July 4th 18
SGX:BBW Historical Debt July 4th 18

Next Steps:

ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. Azeus Systems Holdings exhibits a weak ROE against its peers, as well as insufficient levels to cover its own cost of equity this year. Although, its appropriate level of leverage means investors can be more confident in the sustainability of Azeus Systems Holdings’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 Azeus Systems Holdings, I’ve compiled three pertinent 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 Azeus Systems Holdings 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 Azeus Systems Holdings is currently mispriced by the market.
  3. Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Azeus Systems Holdings? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!