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Why 58com Inc’s (NYSE:WUBA) ROE Of 7.37% Does Not Tell The Whole Story

This article is intended for those of you who are at the beginning of your investing journey and want to begin learning the link between company’s fundamentals and stock market performance.

58com Inc (NYSE:WUBA) delivered a less impressive 7.37% ROE over the past year, compared to the 12.22% return generated by its industry. Though WUBA’s recent performance is underwhelming, it is useful to understand what ROE is made up of and how it should be interpreted. Knowing these components can change your views on WUBA’s below-average returns. I will take you through how metrics such as financial leverage impact ROE which may affect the overall sustainability of WUBA’s returns.

Check out our latest analysis for 58.com

Breaking down Return on Equity

Firstly, Return on Equity, or ROE, is simply the percentage of last years’ earning against the book value of shareholders’ equity. For example, if the company invests $1 in the form of equity, it will generate $0.074 in earnings from this. In most cases, a higher ROE is preferred; however, there are many other factors we must consider prior to making any investment decisions.

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Return on Equity = Net Profit ÷ Shareholders Equity

Returns are usually compared to costs to measure the efficiency of capital. 58.com’s cost of equity is 11.37%. This means 58.com’s returns actually do not cover its own cost of equity, with a discrepancy of -4.00%. This isn’t sustainable as it implies, very simply, that the company 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

NYSE:WUBA Last Perf August 16th 18
NYSE:WUBA Last Perf August 16th 18

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 reveals how much revenue can be generated from 58.com’s asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. Since ROE can be inflated by excessive debt, we need to examine 58.com’s debt-to-equity level. At 3.78%, 58.com’s debt-to-equity ratio appears low and indicates that 58.com still has room to increase leverage and grow its profits.

NYSE:WUBA Historical Debt August 16th 18
NYSE:WUBA Historical Debt August 16th 18

Next Steps:

ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. 58.com exhibits a weak ROE against its peers, as well as insufficient levels to cover its own cost of equity this year. Although, its appropriate level of leverage means investors can be more confident in the sustainability of 58.com’s return with a possible increase should the company decide to increase its debt levels. Although ROE can be a useful metric, it is only a small part of diligent research.

For 58.com, there are three essential factors you should look at:

  1. 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.

  2. Valuation: What is 58.com 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 58.com is currently mispriced by the market.

  3. Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of 58.com? 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 past 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. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.