Riverstone Holdings Limited (SGX: AP4) is a Malaysia based company operating in two key areas of the rubber gloves industry: cleanroom gloves and medical gloves.
In this article, we will dig deep into Riverstone’ return on equity, or ROE.
The choice of ROE
Some of you might be asking, why ROE? ROE is a financial metric gives investors important insights on a company’s ability to generate a profit using its shareholders’ capital.
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 return on equity
The ROE can be calculated using the following formula:
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 ROE, you can check out this article.
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 817.4 million, and total assets of RM 778.4 million for its fiscal year ended 31 December 2017 (FY2017). This gives an asset turnover of 1.05.
The net profit margin measures the percentage of revenue that is left as a profit after deduction of all expenses. In FY2017, Riverstone had a net profit margin of 15.6%, given its net profit of RM 127.6 million and revenue of RM 817.4 million.
Lastly, we have the leverage ratio, which shows the relationship between 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, Riverstone had total assets and total equity of RM 778.4 million and RM 632.6 million, respectively. This gives a leverage ratio of 1.23.
When we put all the numbers together, we arrive at an ROE of 20%.
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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. Motley Fool has a recommendation for Riverstone Holdings Ltd.