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Here Is 1 Important Number To Help Investors Gain Better Insight On First Resources Ltd

Credit: Simon Cunningham

First Resources Ltd (SGX: EB5) is one of the few palm oil producers listed in Singapore’s stock market.  It manages over 200,000 hectares of oil palm plantations across the Riau, East Kalimantan, and West Kalimantan provinces of Indonesia.

Over the past five years, its stock has gained 30%. While that isn’t a fantastic return by any measure, it is still better than most of the other oil palm companies in the local market.

In here, I want to use the return on equity (ROE) to gain deeper insight on First Resources’ business.

The choice of ROE

Some of you may wonder what makes the ROE number useful. Thing is, it is a measure of a company’s ability to generate a profit with each dollar of investors’ capital that’s invested in the business.

A ROE of 20% means that a company generates $0.20 in profit for every dollar of shareholders’ capital invested. In general, the higher the ROE, the more profitable a company is. That being said, it’s worth noting that the use of high leverage – which increases the financial risk faced by a company – can also increase a company’s ROE. So, that’s something to observe.

Calculating the ROE

The ROE can be calculated using the following formula, which is the way many investors do it:

ROE = Net Profit / Shareholder’s Equity

But, the ROE can also be calculated using a different approach shown below:

ROE = Asset Turnover x Net Profit Margin x Leverage Ratio

Doing so will reveal three important aspects about a company: How well it is managing its assets, how efficient it is at turning revenue into profit, and how much financial risk it could be taking on. For more information about this formula for the ROE, you can check out here.

So, let’s find out the ROE for First Resources.

The actual numbers

The asset turnover measures the efficiency of a company in using its assets to generate revenue. It is calculated by dividing a company’s total assets with its revenue. For First Resources, its asset turnover in 2015 is 0.235 (US$453.7 million in total assets divided by US$1.927 billion in revenue).

The net profit margin measures the percentage of revenue that is left as a profit after deduction of all expenses. In 2015, the net margin for First Resources was 24.66%.

Lastly, we have the leverage ratio, which shows the relationship of a company’s total assets to its shareholders’ equity. It is calculated by dividing total assets with shareholders’ equity. A higher ratio means that a company is funding its assets with more liabilities, hence resulting in higher risk. In 2015, First Resources had a leverage ratio of 1.84.

When we put all the numbers together, we end up with a ROE of 10.7% for First Resources. This is modestly higher than the ROE of 9.7% that the market has right now.

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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 Lawrence Nga doesn’t own shares in any companies mentioned.