# 1 Simple Number For Understanding 3 Important Areas Of Oversea-Chinese Banking Corp Limited’s Business

Oversea-Chinese Banking Corp Limited (SGX: O39) is one of the three major banks based out of Singapore. In this article, I want to dig deep into OCBC’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 OCBC.

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 OCBC, it had total revenue (or total income, in the case of a bank) of S\$9.6 billion, and total assets of S\$454.9 billion, in its fiscal year ended 31 December 2017. This gives a really low asset turnover of 0.021.

The net profit margin measures the percentage of revenue that is left as a profit after deduction of all expenses. In 2017, OCBC had a fat net profit margin of 45.8%, given its net profit of S\$4.4 billion and revenue of S\$9.6 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. In 2017, OCBC had total assets and total equity of S\$454.9 billion and S\$41.8 billion, respectively. This gives a really high leverage ratio of 10.9, which looks dangerous at first glance. But, it should be noted that a high leverage ratio is normal for banks.

When we put all the numbers together, we arrive at a respectable ROE of 10.5%.

The Behind-the-Scenes Story on Motley Fool Singapore’s Biggest Winner Ever

Members of David Kuo’s personal investing club Stock Advisor Gold were recently rewarded with the biggest winner Motley Fool Singapore has seen to date – an 88% return in just 19 months! In a special, 100% FREE report we’ve put together, we take you behind the scenes to show you exactly how we first uncovered this stock… every article and piece of research we released on it… and what ultimately led to our decision to SELL for an 88% gain. Click here to claim your copy!

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.