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1 Simple Number To Help Investors Understand 3 Important Aspects Of United Overseas Bank Ltd’s Business

United Overseas Bank Ltd (SGX: U11) is one of Southeast Asia’s largest banks with total assets of S$327.8 billion. It is also one of the largest stocks in Singapore’s stock market and accounts for nearly 10% of the local market barometer, the Straits Times Index (SGX: ^STI).

In this article I want to dig deep into the bank’s return on equity, or ROE.

The choice of ROE

Why the ROE some of you might be asking? That’s because 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.

With that, let’s turn our attention back to the ROE of United Overseas Bank.

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 revenue by its assets. For United Overseas Bank, it had an asset turnover of 0.0255 in 2015 given its total assets of S$316.0 billion and revenue of S$8.048 billion.

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 margin for United Overseas Bank was 40% (the bank reported a net profit of S$3.220 billion; we already know its revenue figure).

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 by shareholders’ equity. A higher ratio means that a company is funding its assets with more liabilities, hence resulting in higher risk. United Overseas Bank had shareholders’ equity of S$30.924 billion and total assets of S$316.0 billion in 2015; these figures give rise to a leverage ratio of 10.22.

When we put all the three numbers together for United Overseas Bank, we arrive at a ROE of 10.4%. This is very close to the ROE of 10.7% that Singapore’s largest bank, DBS Group Holdings Ltd (SGX: D05), recorded in 2015.

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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 United Overseas Bank. Motley Fool Singapore contributor Lawrence Nga doesn’t own shares in any companies mentioned.