1 Simple Number To Help Investors Understand 3 Important Aspects Of Dutch Lady Milk Industries Bhd’s Business

Dutch Lady Milk Industries Bhd (KLSE: 3026.KL), a dairy products company, is based and listed in Malaysia. It offers a range of dairy products (from specialised milk powders for pregnant women to yoghurts) and is a leading company in Malaysia’s dairy market.

Investors in Fraser and Neave Limited (SGX: F99) may want to pay some attention to Dutch Lady. Fraser and Neave’s Malaysian-listed subsidiary, Fraser & Neave Holdings Bhd (KLSE: 3689.KL), is one of Dutch Lady’s major competitors. And, Fraser & Neave accounted for around three-quarters of its parent company’s profit after tax in the 12 months ended 30 September 2016.

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

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 Dutch Lady, its asset turnover in 2016 was a strong 2.01, given its total revenue of RM 1.048 billion and total assets of RM 520.9 million.

The net profit margin measures the percentage of revenue that is left as a profit after deduction of all expenses. In 2016, Dutch Lady had a respectable net profit margin of 14.2% given its net profit of RM 149.1 million and revenue that 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. Dutch Lady had total equity of RM 165.5 million in 2016. Together with its total assets that we’ve seen, the company thus had a leverage ratio of a high 3.15.

When we put all the three numbers together for Dutch Lady, we arrive at a really strong ROE of 90%.

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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.