- Oops!Something went wrong.Please try again later.
I am writing today to help inform people who are new to the stock market and want to begin learning the link between company’s fundamentals and stock market performance.
Ambow Education Holding Ltd (NYSEMKT:AMBO) delivered an ROE of 27.7% over the past 12 months, which is an impressive feat relative to its industry average of 12.5% during the same period. While the impressive ratio tells us that AMBO has made significant profits from little equity capital, ROE doesn’t tell us if AMBO has borrowed debt to make this happen. Today, we’ll take a closer look at some factors like financial leverage to see how sustainable AMBO’s ROE is.
Breaking down ROE — the mother of all ratios
Return on Equity (ROE) weighs Ambow Education Holding’s profit against the level of its shareholders’ equity. For example, if the company invests $1 in the form of equity, it will generate $0.28 in earnings from this. 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
Returns are usually compared to costs to measure the efficiency of capital. Ambow Education Holding’s cost of equity is 10.4%. Since Ambow Education Holding’s return covers its cost in excess of 17.3%, its use of equity capital is efficient and likely to be sustainable. Simply put, Ambow Education Holding 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 Ambow Education Holding 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 inflated by excessive debt, we need to examine Ambow Education Holding’s debt-to-equity level. The debt-to-equity ratio currently stands at a low 18.2%, meaning the above-average ROE is due to its capacity to produce profit growth without a huge debt burden.
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. Ambow Education Holding’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 Ambow Education Holding, there are three important 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.
Future Earnings: How does Ambow Education Holding’s growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Ambow Education Holding? 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 firstname.lastname@example.org.