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1 Simple Number To Help Investors Gain Better Insight On StarHub Ltd And Telekom Malaysia

There are a total of seven main telecommunications companies in Singapore and Malaysia.

Three of them belong to Singapore, and they are namely, Singapore Telecommunications Limited (SGX: Z74)StarHub Ltd  (SGX: CC3), and M1 Ltd (SGX: B2F).

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Across the causeway in Bursa Malaysia, Malaysia’s stock exchange, there is the quartet of Telekom Malaysia Berhad (KLSE: 4863.KL), Axiata Group Berhad (KLSE: 6888.KL), MAXIS BERHAD (KLSE: 6012.KL) and DiGi.Com Bhd (KLSE: 6947.KL).

In this article, my focus will be on StarHub and Telekom Malaysia. Both are significant players in their respective home markets given the size of their revenues – over the last 12 months, StarHub and Telekom have revenues of S$2.4 billion and S$3.96 billion.

What I’d like to do with the two companies is to look at their return on equity (ROE).

The choice of ROE

Why the ROE some of you might be asking? The financial metric gives investors important insight on a company’s ability to generate a profit using the shareholders’ capital it has.

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 both StarHub and Telekom Malaysia.

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 StarHub, its asset turnover in 2015 is 1.28 (S$2.44 billion in total assets divided by S$1.91 billion in revenue). With Telekom Malaysia’s total assets and revenue of RM11.72 billion and RM18.59 billion, it has a total asset turnover of 0.63 for the same period.

The net profit margin measures the percentage of revenue that is left as a profit after deduction of all expenses. In 2015, the net profit margins for StarHub and Telekom Malaysia are 15.23% and just 5.04%.

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, the ratios for StarHub and Telekom Malaysia are 10.18 and 2.31, respectively.

When we put the three components of the ROE together for each company, we arrive at a figure of 198% for StarHub and 7.3% for Telekom Malaysia. While StarHub has a significantly higher ROE, the company had reached that number by leveraging its balance sheet.

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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.