RETURN on equity (ROE) is a metric that has always been an area of focus among investors in listed equities.
In March, DBS chief executive officer Piyush Gupta expressed confidence in the bank achieving an ROE of 15 to 17 per cent in the medium term or over the next three to five years. This comes after Singapore’s largest lender achieved a record ROE of 18 per cent last year.
OCBC CEO Helen Wong, meanwhile, is expecting the bank’s ROE for FY2024 to come in at the higher end of the 13 to 14 per cent range. Its ROE for FY2023 was 13.7 per cent.
On the other hand, UOB chief Wee Ee Cheong said he considered the bank’s target to achieve an ROE of 14 per cent for the current financial year “decent” following FY2023’s 14.2 per cent core ROE.
Other blue-chip names have also cited the metric as a measure of a company’s medium to long-term performance outlook.
Keppel chief executive Loh Chin Hua said he was confident of the group attaining its ROE target of 15 per cent “well before 2030”, while inflight caterer and ground handler Sats aims to attain an ROE of 15 per cent by FY2028 post the group’s Worldwide Flight Services acquisition.
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The Business Times explains what ROE is, how it works, and its significance.
What is ROE?
ROE is a key metric that is calculated by dividing a company’s net profit by its shareholders’ equity. It improves when net profit is higher, and/or when the amount of equity declines.
Investors contribute equity to a business and entrust management to use it to generate returns.
A higher ROE suggests that management is more efficient at generating income and growth.
Why do companies use this metric?
While ROE is an important indicator of how well a company utilises its shareholders’ money, it is also often used to compare a company with its competitors in the same industry or sector.
How are ROE and shareholder value related?
Shareholder value is created when ROE is higher than the cost of equity.
In order to sustain shareholder value in the long term, a company aims to raise its ROE. Typically, it invests in growth opportunities such as research and development to create new products, or expands into new markets to reach a larger customer base.
Limitations of ROE
A high ROE does not necessarily mean that a company is doing well. It could imply potential risks, such as having taken on excessive debt.
As the denominator for the profitability metric, equity is represented by net assets; total assets less liabilities. The more liability a company has, the smaller the shareholders’ equity figure, resulting in a higher earnings per share figure and ROE.
An outsized ROE could also be indicative of inconsistent profits. For instance, a loss-making company that returned to the black may have a smaller equity base after many years of losses, which could result in a very high ROE.
