Do you still remember our earlier introduction of Japanese candlestick techniques? We certainly hope you do. Throughout our series of articles on Japanese candlestick techniques, we have been emphasizing the importance of fundamental analysis, which we believe is the essence of good investing.

In this issue’s Shares Investment (Singapore), we want you to stop predicting the directions of the stock market, the economy, interest rates, oil prices and the US elections. Instead, we want you to focus on analyzing the fundamental value of a company.

As such, we would like to introduce and explain some of the basic tools that can be easily found in our publication to aid you in your analysis. These include return on equity (ROE) and return on assets (ROA).

Return On Equity

ROE enables us to access a firm’s efficiency at generating profits from every dollar of equity, and shows how well a company uses investment dollars to generate growth. For instance, a ratio of 20% means that for every $1 invested, the company yields a profit of 20 cents.

Return On Assets

ROA shows how profitable a company’s assets are in generating earnings. In other words, it is a measure of how effective the company is in engaging its resources to generate profits. For example, a ratio of 40% means that every $1 of asset the company is holding generates a profit of 40 cents.

Meaningful Illustration

Let’s look at Mainboard-listed Raffles Medical Group (RMG) and Thomson Medical Centre (TMC). Although they are both in the healthcare services industry, the financial ratios generated by them differ. Based on the table above, RMG would be the more feasible choice for investment. Firstly, the ROEs and ROAs of RMG are higher than that of TMC. Secondly, RMG’s ROE and ROA are increasing at a faster pace, though in 2007 RMG’s ROA fell, substantially due to an increment in its total assets (acquisition of its own building from Temasek Holdings and Qatar Investment Authority).

However, relying solely on ROE and ROA to make investment decision are definitely not enough to ensure profitable returns. This method of valuation is quantitative; it relies solely on the numbers from companies’ financial statements.

In the next issue of Shares Investment (Singapore), we would be looking at another two important financial ratios, namely the Net Asset Value and the Price Earnings Ratio.