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1 Simple Number For Understanding 3 Important Areas Of Riverstone Holdings Limited’s Business

Credit: Rvierstone Holdings Limited

Riverstone Holdings Limited (SGX: AP4) is a Malaysia-based company producing rubber gloves for both the cleanroom as well as medical industries.

Over the past five years, Riverstone’s stock price has climbed by an impressive 440%. In this article, I want to dig deep into Riverstone’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. A high ROE can also be a sign that a company has a high quality business.

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 to the ROE of Riverstone.

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 Riverstone, it had total revenue of RM 654.9 million, and total assets of RM 667.6 million, in 2016. This gives a pretty low asset turnover of 0.98.

The net profit margin measures the percentage of revenue that is left as a profit after deduction of all expenses. In 2016, Riverstone had an impressive net margin of 18.4% given its net profit of RM 120.4 million.

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. Riverstone had total assets and total equity of RM 667.6 million and RM 554.5 million, respectively, in 2016. This gives a leverage ratio of a healthy 1.2.

When we put all the numbers together, we arrive at a solid ROE of 21.6% for Riverstone.

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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. The Motley Fool Singapore has recommended Riverstone Holdings.