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1 Simple Number For Understanding 3 Important Areas Of Hong Leong Financial Group Berhad’s Business

Hong Leong Financial Group Berhad (KLSE: 1082.KL) is one of the leading financial institutions in Malaysia.  Although it shares a very similar name with the Singapore-based and Singapore-listed Hong Leong Finance Ltd (SGX: S41), the two companies have little to do with each other.

For investors interested in Singapore’s big banks such as DBS Group Holdings Ltd (SGX: D05), Oversea-Chinese Banking Corp Limited (SGX: O39), and United Overseas Bank Ltd (SGX: U11), it may also be worthwhile to look at the business of Hong Leong Financial Group, just to see how the Singapore banks stack up against the Malaysian company.

In this article, I want to dig deep into Hong Leong Financial 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. 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 Hong Leong Financial 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 Hong Leong Financial Group, it had total revenue of RM 5.035 billion, and total assets of RM 218.962 billion at the end of its fiscal year ended 30 June 2017 (FY2017). This gives a low asset turnover of 0.023.

The net profit margin measures the percentage of revenue that is left as a profit after deduction of all expenses. In FY2017, Hong Leong Financial Group had an impressive net margin of 46.0% given its net prpfit of RM 2.317 billion and revenue of RM 5.035 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. Hong Leong Financial Group had total assets and total equity of RM 218.962 billion and RM 25.033 billion, respectively, at the end of FY2017. This gives a leverage ratio of 8.75.

At first glance, the leverage ratio of 8.75 may seem high compared to other types of businesses. But, it is common amongst financial institutions. In fact, a leverage ratio of 8.75 is on the low end.

When we put all the numbers together, we arrive at a respectable ROE of 9.26% for Hong Leong Financial Group.

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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 recommendations for DBS Group and United Overseas Bank.