|Not this roe lah!|
I think it's important to use Dupont analysis of ROE to break up the components of ROE into 3 main categories:
- Financial leverage = Total assets / Equity
- Assets turnover = Revenue / Assets
- Net margin = Profits after tax (PAT)/ Revenues
If you take the 3 ratios above and multiply them, you'll find that the denominator and numerator of most components will cancel each other, giving you :
ROE = Total assets/Equity x Revenue/Assets x PAT/Revenues = PAT/equity
That is the standard formula for the computation of ROE
Let's use some concrete examples. I randomly take 3 STI components, SGX, ST Eng and Capitaland. They have nothing to do with each other (in terms of the business they do). The only commonality is that they have easily accessible annual reports so that I don't have to plow through everything to get the numbers required. Lazy, I know :)
So here it goes:
If you look at the ROE component, you'll have realised that ST Engineering's ROE is high because it is more highly geared up. Basically with leverage, you'll have a multiplier effect on your gains or your losses. That's not necessary bad, it's just that if you compare ROE alone, you'll miss that fact.
Again, if you look at the ROE of SGX, you'll find that the main component driving it is actually it's high net margins. That super delicious net margins pushes up the ROE. That is not necessary good or bad, it's just something that might not be noticed if you just focus on ROE alone.
You can dig more about ROE in my previous post here. The real important one is the 2nd link, but it's riddled with broken links of pictures...argh..
1. Dupont analysis of ROE
2. Woe be to those who missed out ROE
(I apologise for the lack of pictures...the server that I had uploaded the pictures went bust...so it's gone)