Raffles Medical Group Ltd’s Investors Should Know This Investing Formula

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 greater detail:

ROE = Profit Margin x Asset Turnover x Equity Multiplier

The breakdown of the ROE is actually the DuPont formula, created in the 1920s by the DuPont Corporation to measure the company’s own internal efficiency.

In this piece, I want to use the formula on Raffles Medical Group (SGX: BSL) to investigate the changes in the company’s ROE over its last five fiscal years.

As you can see from the chart just below, Raffles Medical Group has been enjoying ROEs of over 10% from 2011 to 2015 (this is despite its equity base doubling from S$330 million to S$622 million). But, it’s worth noting that the ROE has also been declining, except for a spike in 2013.

Raffles Medical ROE chart - wilson
Source: Raffles Medical Group’s annual report

As a brief background, Raffles Medical Group is a healthcare services provider with two major business divisions: Healthcare Services and Hospital Services. The first houses businesses such as medical clinics, health insurance, consultancy services, and more. The second includes the company’s specialist medical services and its current flagship asset, Raffles Hospital.

Let us now deconstruct Raffles Medical Group’s ROE with the DuPont formula.

Raffles Medical profit margin chart - wilson
Source: Raffles Medical Group’s annual report

The first component of the DuPont formula is the profit margin. Raffles Medical Group displayed solid top-line growth from 2011 to 2015 with its revenue increasing from S$273 million to S$410 million. The company has also managed to maintain its profit margin in the 16% to 25% range, though it has fallen slightly over the years.

Raffles Medical asset turnover and equity multiplier chart - wilson
Source: Raffles Medical Group’s annual report

The second component of the DuPont formula is the asset turnover, which measures how good Raffles Medical Group 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.

Raffles Medical Group’s asset turnover has decreased despite the aforementioned revenue growth. This means its assets have grown disproportionately more. The company may be expanding its business, but it has become less efficient at utilizing its assets.

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 thus financial risk – Raffles Medical Group is taking on.

You can observe how the healthcare outfit’s equity multiplier was drifting down slightly from 2011 to 2014 until 2015, when the company increased its debt (from S$6.4 million in 2014 to S$32.3 million in 2015) to finance the expansion of Raffles Hospital. When the expansion project is completed (Raffles Medical Group expects the project to be done in 2017), Raffles Hospital’s current floor area will increase by around 80%.

Raffles Medical recently revealed its intention to spend S$1 billion over the next three years to set up hospitals and clinics in Asia. The company mentioned that it may take on more debt to fund the investments.

A Fool’s take

To sum up what the DuPont formula has showed us, Raffles Medical Group has consistently generated a double-digit ROE in recent years. But, the expansion in its asset base has caused its asset turnover to fall. Together with a slight dip in the profit margin, these has led to a lower ROE in 2015 as compared to 2011.

It should be noted that more work needs to be done beyond the DuPont analysis before any firm investing conclusion can be made on Raffles Medical Group. This 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. The Motley Fool Singapore has recommended shares of Raffles Medical Group. Motley Fool Singapore contributor Wilson Ong doesn’t own shares in any companies mentioned.