With a 27% return on equity, is China Risun Group Limited (HKG: 1907) a premium stock?

One of the best investments we can make is in our own knowledge and skills. With that in mind, this article will discuss how we can use Return on Equity (ROE) to better understand a business. We will use the ROE to examine China Risun Group Limited (HKG: 1907), through a concrete example.

Return on equity or ROE is a key metric used to assess the efficiency with which the management of a business is using business capital. In simpler terms, it measures a company’s profitability relative to equity.

Check out our latest analysis for China Risun Group

How to calculate return on equity?

Return on equity can be calculated using the formula:

Return on equity = Net income (from continuing operations) ÷ Equity

So, based on the above formula, the ROE for China Risun Group is:

27% = CN ¥ 3.0b ÷ CN ¥ 11b (based on the last twelve months to June 2021).

The “return” is the amount earned after tax over the past twelve months. One way to conceptualize this is that for every HK $ 1 of shareholder capital it has, the company has made a profit of HK $ 0.27.

Does China Risun Group have a good ROE?

Perhaps the easiest way to assess a company’s ROE is to compare it to the industry average. The limitation of this approach is that some companies are very different from others, even within the same industry classification. Fortunately, China Risun Group has an above-average ROE (11%) for the chemical industry.

SEHK: 1907 Return on equity October 13, 2021

This is clearly a positive point. Keep in mind that a high ROE doesn’t always mean superior financial performance. Besides changes in net income, high ROE can also be the result of high leverage to equity, which indicates risk. Our risk dashboard should include the 3 risks that we have identified for China Risun Group.

What is the impact of debt on return on equity?

Most businesses need money – from somewhere – to increase their profits. This liquidity can come from retained earnings, the issuance of new shares (shares) or debt. In the first and second cases, the ROE will reflect this use of cash for investing in the business. In the latter case, the debt necessary for growth will increase returns, but will have no impact on equity. So, using debt can improve ROE, but with added risk in stormy weather, metaphorically speaking.

Combine the debt of China Risun Group and its return on equity of 27%

China Risun Group uses a large amount of debt to increase returns. Its debt to equity ratio is 1.07. Its ROE is pretty impressive though, it probably would have been lower without the use of debt. Investors should think carefully about how a business will perform if it weren’t able to borrow so easily, as credit markets change over time.

Conclusion

Return on equity is useful for comparing the quality of different companies. In our books, the highest quality companies have a high return on equity, despite low leverage. If two companies have the same ROE, then I would generally prefer the one with the least amount of debt.

But ROE is only one piece of a bigger puzzle, as high-quality companies often trade at high earnings multiples. Especially important to consider are the growth rates of earnings, relative to expectations reflected in the share price. You might want to take a look at this data-rich interactive chart of the forecast for the business.

Sure China Risun Group May Not Be The Best Stock To Buy. So you might want to see this free collection of other companies with high ROE and low leverage.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative material. Simply Wall St does not have any position in the mentioned stocks.

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