SATS Ltd (SGX: S58) is a company providing food solutions and gateway services solutions. The Food Solutions segment covers airline catering, food distribution, and industrial catering, whereas the Gateway Solutions segment is involved in the ground handling services of passengers, flights, and cargo.
Let’s dig deep into SATS’s return on equity, or ROE.
The choice of ROE
We’re using one metric — the return on equity, or ROE — to understand SATS’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 $0.20 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
ROE can be calculated using the following formula, which is the way many investors do it:
ROE = Net Profit / Shareholder’s Equity
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 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 ROE.
With that, let’s turn our attention to the ROE of SATS.
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.
SATS had total revenue of S$1,828 million and total assets of S$2,408 million in its fiscal year ended 31 March 2019 (FY2019). This gives it an asset turnover of 0.76.
Net profit margin measures the percentage of revenue that is left as a profit after deducting all expenses. In FY2019, SATS had a net profit margin of 14.0%, given its net profit of S$256 million and revenue of S$1,828 million.
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, hence resulting in higher risk. In FY2019, SATS had total assets and total equity of S$2,408 million and S$1,817 million, respectively. This gives it a leverage ratio of 1.33.
When we put all of the numbers together, we arrive at a ROE of 14%.
Return on equity is a good metric to use to understand the quality of a business, but investors should be aware of (and understand) all three components that make up the ROE. I usually pay more attention to asset turnover and profit margin since those two metrics better reflect a company’s underlying business performance.
Last but not least, calculating the ROE is just the start of our research of a company. We should also compare SATS’s ROE with those of its peers, as well as its historical ROE, in order to get a better understanding of SATS’s performance.
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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 SATS Ltd.