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Is S.A.S. Dragon Holdings Limited's (HKG:1184) 18% ROE Better Than Average?

Simply Wall St

One of the best investments we can make is in our own knowledge and skill set. With that in mind, this article will work through how we can use Return On Equity (ROE) to better understand a business. We'll use ROE to examine S.A.S. Dragon Holdings Limited (HKG:1184), by way of a worked example.

S.A.S. Dragon Holdings has a ROE of 18%, based on the last twelve months. Another way to think of that is that for every HK$1 worth of equity in the company, it was able to earn HK$0.18.

See our latest analysis for S.A.S. Dragon Holdings

How Do I Calculate ROE?

The formula for return on equity is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

Or for S.A.S. Dragon Holdings:

18% = HK$333m ÷ HK$1.8b (Based on the trailing twelve months to June 2019.)

It's easy to understand the 'net profit' part of that equation, but 'shareholders' equity' requires further explanation. It is all earnings retained by the company, plus any capital paid in by shareholders. The easiest way to calculate shareholders' equity is to subtract the company's total liabilities from the total assets.

What Does Return On Equity Mean?

ROE measures a company's profitability against the profit it retains, and any outside investments. The 'return' is the yearly profit. The higher the ROE, the more profit the company is making. So, as a general rule, a high ROE is a good thing. That means ROE can be used to compare two businesses.

Does S.A.S. Dragon Holdings Have A Good ROE?

By comparing a company's ROE with its industry average, we can get a quick measure of how good it is. Importantly, this is far from a perfect measure, because companies differ significantly within the same industry classification. As you can see in the graphic below, S.A.S. Dragon Holdings has a higher ROE than the average (10%) in the Electronic industry.

SEHK:1184 Past Revenue and Net Income, January 29th 2020

That's clearly a positive. In my book, a high ROE almost always warrants a closer look. For example, I often check if insiders have been buying shares.

How Does Debt Impact ROE?

Most companies need money -- from somewhere -- to grow their profits. That cash can come from issuing shares, retained earnings, or debt. In the first and second cases, the ROE will reflect this use of cash for investment in the business. In the latter case, the debt required for growth will boost returns, but will not impact the shareholders' equity. That will make the ROE look better than if no debt was used.

Combining S.A.S. Dragon Holdings's Debt And Its 18% Return On Equity

S.A.S. Dragon Holdings does use a significant amount of debt to increase returns. It has a debt to equity ratio of 1.46. while its ROE is respectable, it is worth keeping in mind that there is usually a limit to how much debt a company can use. Debt does bring extra risk, so it's only really worthwhile when a company generates some decent returns from it.

In Summary

Return on equity is a useful indicator of the ability of a business to generate profits and return them to shareholders. In my book the highest quality companies have high return on equity, despite low debt. All else being equal, a higher ROE is better.

But ROE is just one piece of a bigger puzzle, since high quality businesses often trade on high multiples of earnings. The rate at which profits are likely to grow, relative to the expectations of profit growth reflected in the current price, must be considered, too. Check the past profit growth by S.A.S. Dragon Holdings by looking at this visualization of past earnings, revenue and cash flow.

But note: S.A.S. Dragon Holdings may not be the best stock to buy. So take a peek at this free list of interesting companies with high ROE and low debt.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.