Thai Beverage Public Company Limited (SGX: Y92) is a food and beverage company operating in four different segments, namely, Spirits, Beer, Food, and Non-Alcoholic Beverages. In this article, I want to dig deeper into Thai Beverage’s return on equity, or ROE.
The choice of ROE
Why ROE? That’s because the financial metric gives investors important insight into a company’s ability to generate a profit using shareholders’ capital.
An 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. You can find out more about this formula here.
With that, let’s turn our attention to the ROE of Thai Beverage.
The actual numbers
The asset turnover measures the efficiency of a company in using its assets to generate revenue. It’s calculated by dividing a company’s total revenue by its assets.
For Thai Beverage, it had revenue of THB 232.6 billion and total assets of THB 401.4 billion in its fiscal year ended 30 September 2018 (FY2018). This gives it an asset turnover of 0.58.
The net profit margin measures the percentage of revenue that is left as a profit after deduction of all expenses. In FY2018, Thai Beverage had a net profit margin of 8.9%, given its net profit of THB 20.7 billion and revenue of THB 232.6 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 FY2018, Thai Beverage had total assets and total equity of THB 401.4 billion and THB 140.6 billion, respectively. This gives it a leverage ratio of 2.85.
When we put all the numbers together, we arrive at an ROE of 15%.
The Foolish takeaway
Return on equity is a good metric to understand the quality of a business. We should be aware of all three components that make up the ROE. In general, I will pay more attention to asset turnover and profit margin since those two metrics better reflect Thai Beverage’s underlying business performance. We should also compare Thai Beverage’s ROE with its peers, as well as it historical ROE, to get a better overall picture.
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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.