Singapore Technologies Engineering Ltd (SGX: S63), or STE, is a conglomerate with many business segments, namely, aerospace, electronics, land systems, marine and others.
In this article, I want to dig deep into STE’s return on equity, or ROE.
The choice of ROE
Why 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.
The simplified calculation that most investors use is as follows:
ROE = net profit / shareholder’s equity
Here, however, we will take a different approach to calculate the ROE:
ROE = asset turnover x net profit margin x asset/equity
Doing so will reveal to us three pillars of the company – asset management, profitability and financial leverage. For more information about this breakdown, please head here.
With that, let’s calculate the ROE of STE.
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 STE, it had total revenue of S$6.6 billion, and total assets of S$8.5 billion, in its fiscal year ended 31 December 2017 (FY2017). This gives an asset turnover of 0.776.
The net profit margin measures the percentage of revenue that is left as a profit after deduction of all expenses. In FY2017, STE had a net profit margin of 8.1%, given its net profit of S$535.4 million and revenue of S$6.6 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 FY2017, STE had total assets and total equity of S$8.5 billion and S$2.5 billion, respectively. This gives a leverage ratio of 3.4.
When we put all the numbers together, we arrive at a ROE of 21.3%.
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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.