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What You Must Know About Kingold Jewelry Inc’s (NASDAQ:KGJI) ROE

The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to start learning about core concepts of fundamental analysis on practical examples from today’s market.

With an ROE of 17.8%, Kingold Jewelry Inc (NASDAQ:KGJI) outpaced its own industry which delivered a less exciting 12.0% over the past year. On the surface, this looks fantastic since we know that KGJI has made large profits from little equity capital; however, ROE doesn’t tell us if management have borrowed heavily to make this happen. We’ll take a closer look today at factors like financial leverage to determine whether KGJI’s ROE is actually sustainable.

See our latest analysis for Kingold Jewelry

Breaking down ROE — the mother of all ratios

Firstly, Return on Equity, or ROE, is simply the percentage of last years’ earning against the book value of shareholders’ equity. For example, if the company invests $1 in the form of equity, it will generate $0.18 in earnings from this. 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 Kingold Jewelry’s equity capital deployed. Its cost of equity is 17.1%. Given a positive discrepancy of 0.7% between return and cost, this indicates that Kingold Jewelry 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:

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

NasdaqCM:KGJI Last Perf September 26th 18
NasdaqCM:KGJI Last Perf September 26th 18

Essentially, profit margin shows how much money the company makes after paying for all its expenses. Asset turnover shows how much revenue Kingold Jewelry 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 Kingold Jewelry’s historic debt-to-equity ratio. At over 2.5 times, Kingold Jewelry’s debt-to-equity ratio is very high and indicates the above-average ROE is generated by significant leverage levels.

NasdaqCM:KGJI Historical Debt September 26th 18
NasdaqCM:KGJI Historical Debt September 26th 18

Next Steps:

ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. Kingold Jewelry’s above-industry ROE is encouraging, and is also in excess of its cost of equity. Its high debt level means its strong ROE may be driven by debt funding which raises concerns over the sustainability of Kingold Jewelry’s returns. Although ROE can be a useful metric, it is only a small part of diligent research.

For Kingold Jewelry, I’ve compiled three important factors you should look at:

  1. 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.

  2. Valuation: What is Kingold Jewelry 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 Kingold Jewelry is currently mispriced by the market.

  3. Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Kingold Jewelry? 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.

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