1 Simple Number To Help Bank Investors Understand 3 Important Aspects Of CIMB Group Holdings, One Of Malaysia’s Largest Banks

Current or potential investors in Singapore’s bank stocks such as DBS Group Holdings Ltd (SGX: D05) and Oversea-Chinese Banking Corp Limited (SGX: O39) may be interested to know more about CIMB Group Holdings Bhd (KLSE: 1023.KL), the third biggest bank by market capitalisation in Bursa Malaysia, Malaysia’s stock market.

In this article, I’m going to take a deep look at CIMB Group’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 CIMB Group.

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 CIMB, it has a low asset turnover of 0.033 for 2016, given its total revenue of RM 16.07 billion and total assets of RM 485.8 billion.

The net profit margin measures the percentage of revenue that is left as a profit after deduction of all expenses. In 2016, the net profit margin for CIMB Group was a solid 20% (net profit of RM 3.622 billion and revenue of RM 16.07 billion).

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. CIMB Group has a healthy leverage ratio of 10.3 given its total assets of RMB 485.8 billion and shareholders’ equity of RM 47.1 billion.

When we put all the three numbers together, we arrive at a ROE of just 7%, which is not very impressive.

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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.