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How Effective Is Great Eastern Holdings Limited In Generating Profits?

Great Eastern Holdings Limited (SGX: G07), a prominent subsidiary of local banking giant Oversea-Chinese Banking Corp Limited (SGX: O39), provides life insurance products. Founded in 1908, Great Eastern is also the oldest and most established life insurance group in Singapore and Malaysia.

In this article, I want to dig deep into Great Eastern’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 how effective a company is in 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 Great Eastern.

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 Great Eastern, it had total revenue of S$12.6 billion and total assets of S$84.6 billion in 2017. This gives a low asset turnover of 0.15.

The net profit margin measures the percentage of revenue that is left as a profit after deduction of all expenses. In 2017, Great Eastern had a net profit margin of an acceptable 9.5%, given its net profit of S$1.2 billion and revenue of S$12.6 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, Great Eastern had total assets and total equity of S$ 84.6 billion and S$ 7.6 billion, respectively. This gives a high leverage ratio of 11.1 in relation to most other types of companies. But it should be noted that high leverage ratios are not uncommon for an insurance companies and banks.

When we put all the numbers together, we arrive at a solid ROE of 16% for Great Eastern.

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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 a recommendation for Oversea-Chinese Banking Corp Limited.