Is ASM Pacific Technology Limited’s (HKG:522) 22.9% ROE Strong Compared To Its Industry?
I am writing today to help inform people who are new to the stock market and want to learn about Return on Equity using a real-life example.
ASM Pacific Technology Limited (HKG:522) outperformed the Semiconductor Equipment industry on the basis of its ROE – producing a higher 22.9% relative to the peer average of 8.5% over the past 12 months. Superficially, this looks great since we know that 522 has generated big profits with little equity capital; however, ROE doesn’t tell us how much 522 has borrowed in debt. Today, we’ll take a closer look at some factors like financial leverage to see how sustainable 522’s ROE is.
Check out our latest analysis for ASM Pacific Technology
Breaking down ROE — the mother of all ratios
Firstly, Return on Equity, or ROE, is simply the percentage of last years’ earning against the book value of shareholders’ equity. It essentially shows how much the company can generate in earnings given the amount of equity it has raised. In most cases, a higher ROE is preferred; however, there are many other factors we must consider prior to making any investment decisions.
Return on Equity = Net Profit ÷ Shareholders Equity
Returns are usually compared to costs to measure the efficiency of capital. ASM Pacific Technology’s cost of equity is 10.4%. Given a positive discrepancy of 12.5% between return and cost, this indicates that ASM Pacific Technology pays less for its capital than what it generates in return, which is a sign of capital efficiency. ROE can be broken down into three different 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
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 ASM Pacific Technology’s asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. Since ROE can be inflated by excessive debt, we need to examine ASM Pacific Technology’s debt-to-equity level. The debt-to-equity ratio currently stands at a low 25.9%, meaning the above-average ROE is due to its capacity to produce profit growth without a huge debt burden.
Next Steps:
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. ASM Pacific Technology’s ROE is impressive relative to the industry average and also covers its cost of equity. ROE is not likely to be inflated by excessive debt funding, giving shareholders more conviction in the sustainability of high returns. Although ROE can be a useful metric, it is only a small part of diligent research.
For ASM Pacific Technology, I’ve compiled three relevant 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 ASM Pacific Technology 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 ASM Pacific Technology is currently mispriced by the market.
Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of ASM Pacific Technology? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.
