How Did Nan Nan Resources Enterprise Limited’s (HKG:1229) 22.1% ROE Fare Against The 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.
Nan Nan Resources Enterprise Limited (HKG:1229) delivered an ROE of 22.1% over the past 12 months, which is an impressive feat relative to its industry average of 10.6% during the same period. Superficially, this looks great since we know that 1229 has generated big profits with little equity capital; however, ROE doesn’t tell us how much 1229 has borrowed in debt. We’ll take a closer look today at factors like financial leverage to determine whether 1229’s ROE is actually sustainable.
Check out our latest analysis for Nan Nan Resources Enterprise
Peeling the layers of ROE – trisecting a company’s profitability
Return on Equity (ROE) is a measure of Nan Nan Resources Enterprise’s profit relative to its shareholders’ equity. An ROE of 22.1% implies HK$0.22 returned on every HK$1 invested. 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
ROE is measured against cost of equity in order to determine the efficiency of Nan Nan Resources Enterprise’s equity capital deployed. Its cost of equity is 17.8%. Since Nan Nan Resources Enterprise’s return covers its cost in excess of 4.3%, its use of equity capital is efficient and likely to be sustainable. Simply put, Nan Nan Resources Enterprise pays less 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
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 Nan Nan Resources Enterprise 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. Since financial leverage can artificially inflate ROE, we need to look at how much debt Nan Nan Resources Enterprise currently has. Currently the debt-to-equity ratio stands at a balanced 149%, which means its above-average ROE is driven by its ability to grow its profit without a significant debt burden.
Next Steps:
ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. Nan Nan Resources Enterprise’s above-industry ROE is encouraging, and is also in excess of its cost of equity. Its high ROE is not likely to be driven by high debt. Therefore, investors may have more confidence in the sustainability of this level of returns going forward. Although ROE can be a useful metric, it is only a small part of diligent research.
For Nan Nan Resources Enterprise, I’ve compiled three fundamental factors you should further examine:
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 Nan Nan Resources Enterprise 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 Nan Nan Resources Enterprise is currently mispriced by the market.
Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Nan Nan Resources Enterprise? 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.
