Yangzijiang Shipbuilding Holdings Ltd (SGX: BS6) is in the business of manufacturing commercial vessels such as container ships, bulk carriers, and liquefied natural gas (LNG) vessels.
Why use ROE?
We’re using the company’s return on equity, or ROE, to give investors important insight into a company’s ability to generate a profit using shareholders’ capital.
A ROE of 20% means 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.
It’s worth noting that the use of high leverage – which increases the financial risk a company faces – can also increase a company’s ROE.
Calculating the ROE
ROE can be calculated using the following formula, which is the way many investors do it:
ROE = Net profit / shareholder’s equity
But ROE can also be calculated using a different approach, as shown below:
ROE = asset turnover x net profit margin x leverage ratio
Calculating a company’s ROE will reveal three important things: how well it’s managing its assets, how efficient it is at turning revenue into profit, and how much financial risk it could be taking on. Click here for more information about this formula for calculating ROE.
With that, let’s turn our attention to Yangzijiang Shipbuilding’s ROE.
The actual numbers
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.
Yangzijiang Shipbuilding had total revenue of RMB 19.2 billion and total assets of RMB 43.4 billion in its fiscal year ended 31 December 2017 (FY2017). The combination gives it an asset turnover of 0.442.
Net profit margin measures the percentage of revenue that is left as a profit after deducting all expenses. In FY2017, Yangzijiang Shipbuilding had a net profit margin of 16.1%, given its net profit of RMB 3.1 billion and revenue of RMB 19.2 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 a company is funding its assets with more liabilities, resulting in higher risk. In FY2017, Yangzijiang Shipbuilding had total assets and total equity of RMB 43.4 billion and RMB 26.5 billion, respectively. This gives it a leverage ratio of 1.65.
When we put the numbers together, we arrive at an ROE of 12%.
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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.