As investors, it?s common to focus our attention on a company?s earnings growth and dividend yield as a gauge for the bangs for bucks we are paying for. But, there?s actually another useful yardstick for us to examine to see if we are getting good returns on our money.
Cue the entrance of the Return on Equity. My Foolish colleague David Kuo humorously ? and aptly ? calls it a ?one-duck-eat-three-ways-meal? because the yardstick can be split into…
As investors, it’s common to focus our attention on a company’s earnings growth and dividend yield as a gauge for the bangs for bucks we are paying for. But, there’s actually another useful yardstick for us to examine to see if we are getting good returns on our money.
Cue the entrance of the Return on Equity. My Foolish colleague David Kuo humorously – and aptly – calls it a “one-duck-eat-three-ways-meal” because the yardstick can be split into three individual components in what’s widely known as the DuPont Analysis.
The Dupont Analysis in turn, provides us with useful insights into what makes a company tick.
The former has a high Return of Equity of 23%. In comparison, the average for the 30 companies that make up the Straits Times Index (SGX: ^STI) is only around 10%. So, this makes Sembcorp Marine more than twice as effective at making a profit on every dollar of shareholder capital it holds.
But where does it shine though?
With a Net Profit Margin of 12%, Sembcorp Marine is not as adept at turning sales into profit when compared to the market-average of 19%. The Net Profit Margin tells us the amount of profit made per dollar of revenue.
Looking at the Asset Turnover Ratio, which measures the amount of sales generated on each dollar of asset, we see the company faring slightly better. It has a turnover of 0.82 compared to the market-average of around 0.5
That leaves us with the Leverage Ratio, which is the amount of assets a company has acquired in relation to its equity. In other words, it is also a measure of the amount of liabilities a company has taken on to acquire income-producing assets. Sembcorp Marine has a Leverage Ratio of 2.3, which is higher than the market average of 1.7.
Putting it all together, we now have a better idea on what makes Sembcorp Marine float. Its high Return on Equity of 23% has been achieved through a Net Profit Margin of 12%, Asset Turnover Ratio of 0.82 and Leverage Ratio of 2.2.
It seems that Sembcorp Marine has managed to attain its above-average Return on Equity through a better grasp at utilising assets to generate sales and to effectively lever up its shareholder funds to acquire income-generating assets.
Interestingly, the company has been seeing a declining Return on Equity. The figure previously stood at 34% in 2010 and 29% in 2011. Upon closer inspection, the biggest culprit was the drop in Net Profit Margins from 19% (in both 2010 and 2011) to 12% currently. It might be worthwhile for investors to keep a watchful eye on Sembcorp Marine’s profit margins in the future.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Chong Ser Jing doesn’t own shares in any companies mentioned.