22 September 2011

Be Aware of a Company which Growth in Earnings is Not In Tandem With Growth in Revenue

As what we know that, the formula of ROE is Return on Equity, however, we should split it into Du Pont Formula which is:

Earnings              Revenue           Asset
---------     x      ---------    x    --------
Revenue                Asset             Equity

If we found that the growth in Earnings different from growth in revenue, there are 2 scenarios:

  • Earnings Growth faster than Revenue Growth
    • There could be some non-recurring earnings there, so we have to deduct the non-recurring profit from there and recalculate the earning
    • Some of the cost savings methods are in place. Operation Efficiency is improved
    • The earning growth comes from a new division / products that are not traditionally traded previously 
  • Revenue Growth faster than Earnings Growth 
    • Operations Efficiency Deteriorated
    • Some of the Revenue increased cannot bring in more profit. The company may be in the transition period as more expenses are incurred in the R&D session or Marketing session. 
    • Profit Recognition differs from the Revenue Recognition method. Example: Property Development sector. 

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