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Can Singapore Telecommunications Limited Be A Winning Stock?

At the Motley Fool, we favor businesses with superior operations as they are the ones that can deliver long term returns for investors.

To figure out how well a business is run, we can look into a company’s return on equity (ROE). The ROE is a measure of how much profit a company generates for every shareholder dollar used in the business.

While the ROE is a good measure in itself, we can go a step further to gain even more insights. Breaking the ROE down into three other ratios may help us see how well a company is actually being managed.

Breaking up the ROE

In particular, we are looking to break down the ROE into three metrics, namely the return on sales, return on assets, and financial leverage.

ROE return on equity

With reference to the equation above, the first ratio (net income divided by sales) can be referred to as the return on sales, the second ratio (sales divided by assets) is the return on assets or asset turnover, and the third (assets divided by equity) is financial leverage.

For a succinct description of the individual elements, I turn to a passage from author and analyst Dennis Jean-Jacques’s book 5 Keys to Value Investing:

“Return on sales (ROS) indicates the amount of profits a company is able to keep for each dollar that the company takes in from the sale of goods and services. Asset turnover show the amount of revenues the company is able to generate for each dollar of assets committed. Financial leverage shows investors how many dollars of assets the firm can use for every dollar of equity.”

Putting Singtel to the test

Let’s run communications giant Singapore Telecommunications Limited (SGX: Z74) through this exercise today. Better known as Singtel, the company is the largest of the big three in Singapore’s telecommunications industry with the other two being M1 Ltd  (SGX: B2F) and StarHub Ltd  (SGX: CC3).

In the chart below, you can see how the three components of Singtel’s ROE have changed over its past five fiscal years:

ROE Components SIngtel

Source: Morningstar

First off, we can see that Singtel’s ROE has undergone a slight decline over the period under study, moving from close to 18% in the financial year ended 31 March 2010 (FY2010) to a little over 15% in FY2014. Despite the slight decline, it’s still a good thing to see that Singtel has been able to keep its ROE at a respectable level of above 14%.

When we dig into the components of Singtel’s ROE, we may attribute the change in the metric to the mild decline in the return on sales (see the red line in the graph). This is something investors might want to keep an eye on for the future.

Singtel has been able to churn out an average of about 46 cents of revenue for each asset dollar employed over the past five years. Meanwhile, the company has also been inching up its financial leverage (you can get a feel for this from the green line in the graph). The slight uptick in financial leverage may not be surprising when we look at the gradual rise in Singtel’s borrowings from FY2010 to FY2014.

SingTel's balance sheet

Source: Singtel’s earnings report

A Fool’s take

A winning stock may be found when a company demonstrates a consistent track record of generating superior value for each shareholder dollar it has at its disposal. In Singtel’s case, the company needs to work on its return on sales in order to maintain or improve its ROE.

With that, the onus remains with the Foolish investor to decide if Singtel’s current share price provides an appropriate margin of safety and whether it fits into his or her portfolio.

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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 Chin Hui Leong doesn’t own shares in any companies mentioned.