This article is intended for those of you who are at the beginning of your investing journey and want to better understand how you can grow your money by investing in Metro Holdings Limited (SGX:M01).
Metro Holdings Limited (SGX:M01) outperformed the Department Stores industry on the basis of its ROE – producing a higher 10.59% relative to the peer average of 14.08% over the past 12 months. While the impressive ratio tells us that M01 has made significant profits from little equity capital, ROE doesn’t tell us if M01 has borrowed debt to make this happen. We’ll take a closer look today at factors like financial leverage to determine whether M01’s ROE is actually sustainable. Check out our latest analysis for Metro Holdings
What you must know about ROE
Return on Equity (ROE) weighs Metro Holdings’s profit against the level of its shareholders’ equity. It essentially shows how much the company can generate in earnings given the amount of equity it has raised. While a higher ROE is preferred in most cases, there are several other factors we should consider before drawing any conclusions.
Return on Equity = Net Profit ÷ Shareholders Equity
ROE is assessed against cost of equity, which is measured using the Capital Asset Pricing Model (CAPM) – but let’s not dive into the details of that today. For now, let’s just look at the cost of equity number for Metro Holdings, which is 8.51%. Since Metro Holdings’s return covers its cost in excess of 2.08%, its use of equity capital is efficient and likely to be sustainable. Simply put, Metro Holdings pays less for its capital than what it generates in return. ROE can be dissected into three distinct ratios: net profit margin, asset turnover, and financial leverage. This is called the Dupont Formula:
ROE = profit margin × asset turnover × financial leverage
ROE = (annual net profit ÷ sales) × (sales ÷ assets) × (assets ÷ shareholders’ equity)
ROE = annual net profit ÷ shareholders’ equity
The first component is profit margin, which measures how much of sales is retained after the company pays for all its expenses. Asset turnover reveals how much revenue can be generated from Metro Holdings’s asset base. Finally, financial leverage will be our main focus today. It shows how much of assets are funded by equity and can show how sustainable the company’s capital structure is. Since ROE can be inflated by excessive debt, we need to examine Metro Holdings’s debt-to-equity level. The debt-to-equity ratio currently stands at a low 9.23%, meaning Metro Holdings still has headroom to borrow debt to increase profits.
ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. Metro Holdings’s above-industry ROE is encouraging, and is also in excess of its cost of equity. ROE is not likely to be inflated by excessive debt funding, giving shareholders more conviction in the sustainability of high returns. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.
For Metro Holdings, there are three important aspects you should further examine:
- Financial Health: Does it have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
- Future Earnings: How does Metro Holdings’s growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
- Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Metro Holdings? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!
To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned.