With an ROE of 20.39%, Thai Beverage Public Company Limited (SGX:Y92) outpaced its own industry which delivered a less exciting 11.36% over the past year. On the surface, this looks fantastic since we know that Y92 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 Y92’s ROE is actually sustainable. View our latest analysis for Thai Beverage
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. An ROE of 20.39% implies SGD0.2 returned on every SGD1 invested. 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 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 Thai Beverage, which is 8.38%. Since Thai Beverage’s return covers its cost in excess of 12.02%, its use of equity capital is efficient and likely to be sustainable. Simply put, Thai Beverage pays less for its capital than what it generates in return. ROE can be split up into three useful 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 reveals how much revenue can be generated from Thai Beverage’s 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 Thai Beverage’s historic debt-to-equity ratio. At 156.24%, Thai Beverage’s debt-to-equity ratio appears relatively high and indicates the above-average ROE is generated by significant leverage levels.
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. Thai Beverage exhibits a strong ROE against its peers, as well as sufficient returns to cover 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 Thai Beverage’s returns. Although ROE can be a useful metric, it is only a small part of diligent research.
For Thai Beverage, I’ve put together three essential aspects 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.
- Valuation: What is Thai Beverage 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 Thai Beverage is currently mispriced by the market.
- Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Thai Beverage? 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.