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A Look at 1 Key Investing Formula for Q & M Dental Group (Singapore) Limited

The return on equity (ROE) metric measures a company’s ability to generate a profit with the shareholders’ capital it has.

Generally speaking, a high ROE is preferred over a low one, all things being equal.

But, the ROE alone does not tell the whole story with a company. It can actually be broken down into three separate components:

ROE = Profit Margin x Asset Turnover x Equity Multiplier

Some of you may recognise the breakdown as the Dupont Analysis. It was created nearly a century ago in the 1920s by the Dupont Corporation to analyse the company’s internal efficiency.

In this piece, let’s use the formula on Q & M Dental Group (Singapore) Limited (SGX: QC7) to see what it can tell us about changes in the firm’s ROE over the last five years. Here’s a chart for Q&M’s ROE from 2011 to 2015, showing how the metric has declined:

Q&M ROE chart
Source: S&P Global Market Intelligence

Q&M Dental is a healthcare group and it has been a stellar performer in the Singapore stock market, with its share price rising by a total of 133% over the past three years. The company’s business deals primarily with the operation of dental clinics and hospitals in Singapore, Malaysia, and China.

The first component of the Dupont formula is the profit margin and you can see how Q&M Dental’s profit margin has changed in the past five years in the chart below:

Q&M Profit Margin chart
Source: S&P Global Market Intelligence

From 2011 to 2015, Q & M Dental’s profit margin has actually declined. So, this one of the factors pressuring the company’s ROE.

The next two components in the Dupont formula – the asset turnover and equity multiplier – for Q&M Dental Group are shown in the following chart:

Q&M Asset Turnover and Equity Multiplier chart
Source: S&P Global Market Intelligence

The asset turnover, is a measure of how good Q &M Dental is at utilizing its assets to generate revenue. It is calculated by dividing the company’s revenue with its assets. Generally, a higher asset turnover translates to a better performance.

As shown in the chart above, Q & M Dental’s asset turnover has declined drastically – it is actually the largest driver for the declining ROE. The asset turnover has declined from 1.3 in 2011 to just 0.57 in 2015. While Q&M’s revenue has nearly tripled from S$47.8 million in 2011 to S$124 million in 2015, its assets has grown much faster – it’s up nearly six-fold from S$36.5 million to S$215.9 million.

The last component of the DuPont formula is the equity multiplier and it is found by dividing a company’s assets with its equity. It is a gauge for how much leverage – and hence, financial risks – Q & M Dental is taking on.

From the chart above, we can see a significant increase in the equity multiplier, which leads me to Q & M Dental’s swelling liabilities. For instance, the company’s total borrowings have grown from just S$8.9 million in 2013 to S$79.1 million in 2015.

In general, an increase in the equity multiplier would result in a rising ROE. But in Q & M Dental’s case,  the declining asset turnover has more than offset the higher equity multiplier.

A Fool’s take

To sum up what the DuPont formula has showed us, Q & M Dental has been ramping up the financial risks it is taking on while seeing its ability to sweat its assets fall.

It should be noted that more work needs to be done before any firm investing conclusion can be made on Q & M Dental. This deeper look at the company’s ROE should only be seen as a useful starting point for further research.

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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 Wilson Ong doesn’t own shares in any companies mentioned.