1 Simple Number To Help Investors Understand 3 Important Aspects Of Keppel Corporation Limited’s Business

Source: Fool Editorial

Keppel Corporation Limited (SGX: BN4) is one of the largest conglomerates in Singapore’s stock market. It has four major business segments, namely, Offshore and Marine, Property, Infrastructure, and Investments.

The company’s stock has declined by 37% over the past five years, but over the last 12 months, it has been a pretty solid winner with a 27% gain.

In this article I want to dig deep into Keppel Corp’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 Keppel Corp.

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 Keppel Corp, its asset turnover in 2016 is 0.23. (The company had S$6.767 billion in revenue and S$29.234 billion in total assets.)

The net profit margin measures the percentage of revenue that is left as a profit after deduction of all expenses. In 2016, Keppel Corp recorded a net profit of S$821.8 million. This gives a net profit margin of 12.15% given the company’s revenue, which we already know.

Lastly, we have the leverage ratio, which shows the relationship of a company’s total assets to its equity. It is calculated by dividing total assets by equity. A higher ratio means that a company is funding its assets with more liabilities, hence resulting in higher risk. Keppel Corp had total assets and equity of S$29.234 billion and S$12.334 billion, respectively, giving rise to a leverage ratio of 2.37.

When we put all the three numbers together, we arrive at a ROE of 6.7% for Keppel Corp. It’s worth noting that the company’s ROE has been dropping over the past few years. In 2014 and 2015, the conglomerate generated ROEs of 16.5% and 12.8%, respectively.

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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.