Today we’re digging deep into SBS Transit’s return on equity, or ROE.
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The choice of ROE
We’re using one metric — the return on equity, or ROE — to understand SBS Transit’s business. This financial metric gives investors important insight into a company’s ability to generate a profit using the shareholders’ capital it has.
A ROE of 20% means a company generates 20 cents in profit for every dollar of shareholders’ capital invested. In general, the higher a company’s ROE, the more profitable it 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 faced by a company — can also increase a company’s ROE.
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
The metric 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 in this way will reveal three important things: How well a company is managing its assets, how efficient it is at turning revenue into profit, and how much financial risk it could be taking on. You can learn more about this formula for the ROE.
With that, let’s turn our attention to the ROE of SBS Transit.
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. SBS Transit had total revenue of S$1.38 billion and total assets of S$1.06 billion in its fiscal year ended 31 December 2018. This gives it a good asset turnover of 1.30.
The net profit margin measures the percentage of revenue left as profit after deducting all expenses. In 2018, SBS Transit had a low net profit margin of 5.8% given its net profit of S$80.1 million and revenue of S$1.38 billion.
Lastly, we have the leverage ratio, calculated by dividing a company’s total assets by equity. A higher ratio means a company is funding its assets with more liabilities, resulting in higher risk. In 2018, SBS Transit had total assets and total equity of S$1.06 billion and S$498.4 million, respectively, giving it a healthy leverage ratio of 2.13.
When we put all of the numbers together, we arrive at a strong ROE of 16% for SBS Transit for 2018.
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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 recommends SBS Transit Ltd.