1 Simple Number To Help Investors Understand 3 Important Aspects Of SATS Ltd’s Business

SATS Ltd (SGX: S58) is a company providing inflight and institutional food catering services, and airport and cruise terminal services. Over the past five years, the company’s stock has climbed by 101% in price alone.

In this article, I want to dig deep into SATS’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 SATS.

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. In SATS’s fiscal year ended 31 March 2016 (FY2016), it had total revenue of S$1.698 billion and total assets of S$2.106 billion. This gives a pretty low asset turnover of 0.81.

The net profit margin measures the percentage of revenue that is left as a profit after deduction of all expenses. In its FY2016, SATS had a respectable net profit margin of 12.9% given its net profit of S$218.4 million (we already know its revenue).

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. SATS had total assets and total equity of S$2.106 billion and S$1.565 billion, respectively, in FY2016. This results in a leverage ratio of a healthy 1.35

When we put all the three numbers together, we arrive at a ROE of 14.1% for SATS.

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