With an ROE of 24.92%, Hebron Technology Co Ltd (NASDAQ:HEBT) outpaced its own industry which delivered a less exciting 11.63% over the past year. While the impressive ratio tells us that HEBT has made significant profits from little equity capital, ROE doesn’t tell us if HEBT has borrowed debt to make this happen. We’ll take a closer look today at factors like financial leverage to determine whether HEBT’s ROE is actually sustainable. View our latest analysis for Hebron Technology
Breaking down ROE — the mother of all ratios
Return on Equity (ROE) is a measure of HEBT’s profit relative to its shareholders’ equity. It essentially shows how much HEBT can generate in earnings given the amount of equity it has raised. Generally speaking, a higher ROE is preferred; however, there are other factors we must also consider before making any conclusions.
Return on Equity = Net Profit ÷ Shareholders Equity
ROE is measured against cost of equity in order to determine the efficiency of HEBT’s equity capital deployed. Its cost of equity is 10.46%. Given a positive discrepancy of 14.46% between return and cost, this indicates that HEBT pays less for its capital than what it generates in return, which is a sign of capital efficiency. ROE can be dissected into three distinct 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
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 HEBT can generate with its current asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. Since ROE can be artificially increased through excessive borrowing, we should check HEBT’s historic debt-to-equity ratio. Currently the debt-to-equity ratio stands at a low 2.63%, which means its above-average ROE is driven by its ability to grow its profit without a significant debt burden.
What this means for you:
Are you a shareholder? HEBT’s ROE is impressive relative to the industry average and also covers its cost of equity. Since its high ROE is not likely driven by high debt, it might be a good time to top up on your current holdings if your fundamental research reaffirms this analysis. If you’re looking for new ideas for high-returning stocks, you should take a look at our free platform to see the list of stocks with Return on Equity over 20%.
Are you a potential investor? If HEBT has been on your watch list for a while, making an investment decision based on ROE alone is unwise. I recommend you do additional fundamental analysis by looking through our most recent infographic report on Hebron Technology to help you make a more informed investment decision.
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.