01
ROE return on net assets
Friends who speculate in stocks will pay special attention to this financial indicator - ROE return on equity (Return On Equity). This indicator is also very common in the financial analysis of BI projects, but many people show this financial indicator in BI projects. It's over, and there is no in-depth research. Today we are also from the perspective of analysis, how to learn more industry knowledge, business knowledge, and business focus through ROE, I believe it will inspire everyone.
ROE Return on net assets, rate of return, or return on shareholder equity is often seen in DuPont analysis. What does this mean? One year's ROE is the ratio of net profit to net assets. Generally speaking, the higher the ROE, the better. For example, a listed company that exceeds 10% for 5 consecutive years is relatively excellent, and a company that exceeds 20% is very, very excellent.
What is the possible reason for the high ROE of that company? It may be due to high profits, such as Moutai and the jewelry industry; it may be due to fast turnover, such as the retail industry; it may be due to relatively strong financing capabilities and better use of financial leverage.
This indicator is also equal to: net sales rate x total asset turnover x equity multiplier . Industry characteristics can be reflected from this formula, so in BI analysis, if we want to quickly understand the characteristics of an industry, business analysis or focus of attention, this is a very critical angle.
02
Driving factor 1: net sales margin
The net profit margin of sales is equal to the net profit divided by the operating income, which reflects how profitable the company's products are. Companies like Kweichow Moutai, Yanghe, Dong'e Ejiao, and Hengrui Medicine all have an ROE of around 25%, which is very high. What is the key to high ROE? It is the net profit rate of sales, which is basically maintained between 20% and 30%. Moutai can reach about 50%, which means that it makes money by products. On the income statement, costs, expenses, taxes, and investment income are separated between TOP LINE operating income and BOTTOM LINE net profit. Their cost control is relatively good, and their brand profitability is strong, so their ROE is relatively high. Therefore, in these industries, most of the focus of BI analysis or core business focus is on the sales side and the market side. The way they increase the net profit margin is mainly by means of brand, price increase, and cost control.
What do we call this ROE analysis method? performance attribution.
03
Driver 2: Total asset turnover
The second driver of high ROE is total asset turnover, which is equal to operating income divided by total assets. The total asset turnover rate reflects how fast the turnover of the company's supply chain is, and it is an important indicator that reflects the operating quality and utilization efficiency of all assets of the enterprise. The same two companies with an operating income of 100 million, one company’s assets are only 20 million W, and the other company’s assets are 50 million W. The 20 million W company is better, or the 50 million W company. Obviously, the 2000W company is stronger, because it can leverage 100 million in revenue with 3000W less assets than others, so the turnover efficiency of assets is relatively high. Retail and FMCG industries like Midea Group, Shuanghui, Huadong Medicine, Supor, etc. have a total asset turnover rate above 1, and Shuanghui’s can reach 2, generally 0.8, even 80% or more is considered very good. Analyzing the total asset turnover rate can also pull out important assets, such as fixed asset turnover rate, accounts receivable turnover rate, inventory turnover rate, etc. After careful analysis, more core business details and key driving factors can be seen. For example, the utilization efficiency of warehouses and supply chains, the quality of accounts receivable control, and inventory turnover. Therefore, most of the retail industry has small profits but high sales. Small profits mean low profit margins, which rely on high sales and high turnover efficiency.
Of course, there are also some brands that are both profitable and have high turnover efficiency. Two factors drive high ROE. For example, the ROE of Haitian Flavor Industry can reach 30%, the net sales profit rate is about 25%, and the total asset turnover rate is 98%.
04
Driver 2: Equity Multiplier
The last driver of ROE is the equity multiplier, which is total assets divided by net assets (owners' equity), and total assets equal net assets + liabilities . The greater the debt, the greater the total assets relative to the net assets, and the greater the equity coefficient. The core is debt. This debt is not the shareholder's money, but the borrowed money. It is best to have no interest, such as the upstream supplier's money, a large number of bills payable and accounts payable, the payment cycle is long, and the debt is not paid; for example Like China Railway Group, the proportion of notes payable and accounts receivable is very high. For example, in the case of Vanke and the real estate industry, the main source of debt is the prepayment for the purchase of the house. There is no need to pay any interest on this money. The house is built and handed over. This is high leverage.
In industries that are often leveraged, companies generally have low profit margins and slow asset turnover, but they are good at using other people's money to operate in debt. There is no interest or low interest, and all the money earned belongs to shareholders. The same is true for banks. The asset-liability ratio is over 90%, and the leverage ratio is very high, but the operating cost is very low.
Therefore, in the financial analysis indicators, by decomposing the ROE indicator, we can observe what the industry and the company rely on to make money, and what their business model and operating model are like. Then in BI analysis, it can be roughly judged where the core focus of business operations may be placed. Why do you say this way? Because ROE can also see the company's strategic business model. Enterprises with high net sales margin generally implement a differentiation strategy, and their product market competitiveness and cost control capabilities are relatively strong, and they are not afraid of industry adjustments or price wars. Enterprises with a high asset turnover rate implement a cost-leading strategy, with good management and high efficiency, mainly relying on small profits but quick turnover. Enterprises with high leverage ratio use financial leverage strategy, but the development of enterprises is highly uncertain and cyclical. Such enterprises have the greatest flexibility in terms of high leverage, and their profitability and valuation will fluctuate with the cyclical nature of the industry.
Of course, in ROE, we only dealt with the three core indicators today. In fact, each indicator can be subdivided to see more content. By analyzing their structure and composition, and paying attention to this company for five consecutive years or more After ten years of these structural changes, it is basically possible to figure out how this company or this industry makes money.
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