Yahoo Finance Can Olam International Limited’s (SGX:O32) ROE Continue To Surpass The Industry Average?
The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to begin learning the link between Olam International Limited (SGX:O32)’s return fundamentals and stock market performance.
With an ROE of 8.46%, Olam International Limited (SGX:O32) outpaced its own industry which delivered a less exciting 11.67% over the past year. On the surface, this looks fantastic since we know that O32 has made large profits from little equity capital; however, ROE doesn’t tell us if management have borrowed heavily to make this happen. In this article, we’ll closely examine some factors like financial leverage to evaluate the sustainability of O32’s ROE. Check out our latest analysis for Olam International
Breaking down ROE — the mother of all ratios
Return on Equity (ROE) weighs Olam International’s profit against the level of its shareholders’ equity. An ROE of 8.46% implies SGD0.085 returned on every SGD1 invested. In most cases, a higher ROE is preferred; however, there are many other factors we must consider prior to making any investment decisions.
Return on Equity = Net Profit ÷ Shareholders Equity
Returns are usually compared to costs to measure the efficiency of capital. Olam International’s cost of equity is 8.51%. Since Olam International’s return does not cover its cost, with a difference of -0.055%, this means its current use of equity is not efficient and not sustainable. Very simply, Olam International pays more for its capital than what it generates in return. ROE can be broken down into three different ratios: net profit margin, asset turnover, and financial leverage. This is called the Dupont Formula:
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
Basically, profit margin measures how much of revenue trickles down into earnings which illustrates how efficient the business is with its cost management. Asset turnover shows how much revenue Olam International can generate with its current asset base. And finally, financial leverage is simply how much of assets are funded by equity, which exhibits how sustainable the company’s capital structure is. Since ROE can be inflated by excessive debt, we need to examine Olam International’s debt-to-equity level. The debt-to-equity ratio currently stands at a high 177.13%, meaning the below-average ratio is already being driven by a large amount of debt.
Next Steps:
While ROE is a relatively simple calculation, it can be broken down into different ratios, each telling a different story about the strengths and weaknesses of a company. Olam International’s above-industry ROE is noteworthy, but it was not high enough to cover its own cost of equity. Its debt level is above equity which means its above-industry ROE may be driven by debt funding which raises concerns over the sustainability of Olam International’s returns. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.
For Olam International, I’ve put together three essential 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.
Valuation: What is Olam International worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether Olam International is currently mispriced by the market.
Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Olam International? 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.
