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1 Simple Number To Help Investors Understand 3 Important Aspects of Padini Holdings Bhd’s Business

There are not many clothing retail brand companies in Singapore’s stock market that have been successful long-term investments. But over in Malaysia’s market, Bursa Malaysia, there is Padini Holdings Bhd (KLSE: 7052.KL), which has seen its stock price gain an impressive 783% over the past 10 years.

Padini has a number of fashion retail brands under it, such as Padini, Seed, Padini Authentics, PDI, P&Co, Vincci, and Brands Outlet.

In this article I want to dig deep into Padini’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 Padini.

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 Padini’s fiscal year ended 30 June 2017 (FY2017), it had total revenue of RM 1.571 billion and total assets of RM 881 million. This gives a healthy asset turnover of 1.78.

The net profit margin measures the percentage of revenue that is left as a profit after deduction of all expenses. In its FY2017, Padini had a respectable net profit margin of 10% given its net profit of RM 157 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. Padini had total equity of RM 552 million in FY2017. This results in an acceptable leverage ratio of 1.6 (we already know its total assets).

When we put all the three numbers together, we arrive at a solid ROE of 28.5% for Padini.

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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.