This article is intended for those of you who are at the beginning of your investing journey and want to begin learning the link between Sinosoft Technology Group Limited (HKG:1297)’s return fundamentals and stock market performance.
With an ROE of 19.45%, Sinosoft Technology Group Limited (HKG:1297) outpaced its own industry which delivered a less exciting 7.89% over the past year. Superficially, this looks great since we know that 1297 has generated big profits with little equity capital; however, ROE doesn’t tell us how much 1297 has borrowed in debt. Today, we’ll take a closer look at some factors like financial leverage to see how sustainable 1297’s ROE is. Check out our latest analysis for Sinosoft Technology Group
Peeling the layers of ROE – trisecting a company’s profitability
Return on Equity (ROE) is a measure of Sinosoft Technology Group’s profit relative to its shareholders’ equity. An ROE of 19.45% implies HK$0.19 returned on every HK$1 invested. While a higher ROE is preferred in most cases, there are several other factors we should consider before drawing any conclusions.
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 Sinosoft Technology Group, which is 9.59%. This means Sinosoft Technology Group returns enough to cover its own cost of equity, with a buffer of 9.85%. This sustainable practice implies that the company pays less for its capital than what it generates in return. ROE can be broken down into three different 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
Essentially, profit margin shows how much money the company makes after paying for all its expenses. Asset turnover shows how much revenue Sinosoft Technology Group can generate with its current 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. Since ROE can be inflated by excessive debt, we need to examine Sinosoft Technology Group’s debt-to-equity level. Currently, Sinosoft Technology Group has no debt which means its returns are driven purely by equity capital. Therefore, the level of financial leverage has no impact on ROE, and the ratio is a representative measure of the efficiency of all its capital employed firm-wide.
ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. Sinosoft Technology Group’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 Sinosoft Technology Group, I’ve compiled three key 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 Sinosoft Technology Group 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 Sinosoft Technology Group is currently mispriced by the market.
- Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Sinosoft Technology Group? 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 pass 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.