Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 177

Behind the headline profit numbers

The CEOs of the big four banks were grilled by the House of Representatives’ Standing Committee on Economics last week. The committee wanted to know why Australian banks have higher returns on equity (13.8% ROE) and profits than those in other Western countries and whether it is due to their market power.

This appears to be both an exercise in political point-scoring and data mining. I strongly doubt it would be in the national interest if Australian banks generated the returns of the European banks (4% ROE excluding Deutsche Bank). Weak returns limit internal capital generation and increase financial precariousness and thus the risk of taxpayer-funded bailouts. Indeed, in a more comparable and similarly structured banking market such as Canada (ROE 14.8%) has five dominant trading banks (CIBC, Royal Bank of Canada, Toronto Dominion, Bank of Montreal & the Bank of Nova Scotia) in a highly regulated market. Shareholders could make the case that the Australian bank CEOs are not trying hard enough to generate profit!

This article examines the different measures of corporate profitability for listed companies, looking beyond the billion dollar headline figures.

Measures of profitability

As a fund manager, the $29 billion of raw profit made by Australian banks over the past year does not mean much by itself. I look at the underlying earnings per share (EPS) that my unitholders receive from that profit. We also look at growth in EPS, as a company’s profits can often grow substantially when they make an acquisition, but if that acquisition is funded by issuing a large number of additional shares, profit per share might not actually grow. For example, telecommunications company TPG reported a sensational 60% increase in underlying profit this year after the acquisition of iiNet. However, earnings per share grew at a much lower rate after TPG issued additional shares to fund the purchase.

Additionally, at a company level, we look at measures such as return on assets, equity and profit margins, which can be better measures of how efficient a company’s management is utilising the capital or assets belonging to shareholders in generating the annual profits.

Return on equity

Return on equity (ROE) looks at the profit generated by the equity that the owners have contributed to establish the business. ROE is calculated by dividing a company’s profit by the money shareholders have invested in it. This investment by shareholders includes both the original capital given by shareholders in the Initial Public Offering (IPO) plus retained earnings. Retained earnings are the profits kept by the company in excess of dividends and are used to fund capital expenditure to either maintain or grow the company. Companies with high ROE typically require little in the way of dilutive equity raisings from shareholders to run their business, or may be financed primarily from debt rather than shareholder equity.

The above chart shows the top and bottom five companies in the S&P/ASX100 as ranked by ROE. The top ROE earners contain a packaging company (Amcor), a vitamin company (Blackmores), a fund manager (Magellan), a highly geared utility (Sydney Airport) and a healthcare company (CSL).

The common factor in these businesses is minimal ongoing capital expenditure to run the company. Bringing up the rear are a range of capital-heavy businesses that required a large amount of initial capital to start the business and large capital injections from shareholders to maintain their assets and finance ongoing activities. This sub-set includes energy companies (Santos and Origin), a miner (S32) and a grain handler (Graincorp).

Return on assets

Return on assets (ROA) differs from ROE, as it measures the return a company makes on its total assets. This measure accounts for both the equity and the debt used to purchase the assets that generate profits.

The chart on the right shows the top and bottom companies in the S&P/ASX100 ranked by ROA. Companies generating a high ROA generally have minimal to no debt such as Magellan, Carsales.com or very low debt such as CSL and Cochlear. Here the factor driving profits in internet and healthcare companies is generally a smart idea (online real estate listing replacing paper) or a piece of medical research, rather than expensive tangible assets such as steel mills or airplanes bought with capital raised from both shareholders and lenders.

Similarly fund managers (Magellan) enjoy significant operating leverage, as once the fixed cost of fund distribution, office rent and fund manager salaries are covered, each additional dollar of revenue is almost pure profit that requires minimal capital. Gold miner Northern Star sneaks onto this list due to the combination of high global gold prices and a low capital intensive business model.

Alternatively, companies that have a low return on assets typically require expensive hard assets to generate profit. These assets range from utilities (Transurban, DUET and APA) and energy companies (Santos and Origin). Typically hard asset companies such as Qantas, BlueScope and Boral appear on the list of the bottom ROA companies, but these are all currently enjoying their cyclical time in the sun due to company-specific factors.

Profit margin

Profit margin is calculated by dividing operating profits by revenues and measures the percentage of each dollar a company makes that results in profit to shareholders. Typically, low-margin businesses operate in highly competitive mature industries. The absolute profit margin is not what analysts will look at, but rather the change from year to year, as a declining profit margin may indicate stress and could point to future declines in profits.

The chart on the right shows how companies generating the highest profit margins are monopolies (ASX), fund managers enjoying the operating leverage (Magellan and Perpetual) or internet companies (REA and Carsales.com).

Low profit-margin companies characteristically receive large revenues, but operate in intensely competitive industries such as petrol retailing (Caltex), engineering (Downer) and staples retailing (Woolworths). Graincorp makes this list due to lower grain exports and a relatively poor east coast wheat harvest. Companies with low profit margins are forced to concentrate closely on preventing them from slipping further, as a small change in those margins is likely to have a significant impact on the profit that can be distributed to shareholders.

While the banks deliver large absolute profits and make big headlines, they are not among the most profitable S&P/ASX100 companies in terms of profit margins and returns on assets. The Commonwealth Banks’s 45,129 employees produced a $7.8 billion profit in 2016, but this represented a ROE of 16.5% and a profit or net interest margin of only 2.07% on assets of $933 billion.

 

Hugh Dive is Senior Portfolio Manager at Aurora Funds Management.

 

RELATED ARTICLES

Judging big profits beyond the big headlines

Beware the headlines as averages don’t tell the whole story

What to look for in a profitable turnaround

banner

Most viewed in recent weeks

Raising the GST to 15%

Treasurer Jim Chalmers aims to tackle tax reform but faces challenges. Previous reviews struggled due to political sensitivities, highlighting the need for comprehensive and politically feasible change.

Here's what should replace the $3 million super tax

With Div. 296 looming, is there a smarter way to tax superannuation? This proposes a fairer, income-linked alternative that respects compounding, ensures predictability, and avoids taxing unrealised capital gains. 

100 Aussies: seven charts on who earns, pays, and owns

The Labor government is talking up tax reform to lift Australia’s ailing economic growth. Before any changes are made, it’s important to know who pays tax, who owns assets, and how much people have in their super for retirement.

The rubbery numbers behind super tax concessions

In selling the super tax, Labor has repeated Treasury claims of there being $50 billion in super tax concessions annually, mostly flowing to high-income earners. This figure is vastly overstated.

9 winning investment strategies

There are many ways to invest in stocks, but some strategies are more effective than others. Here are nine tried and tested investment approaches - choosing one of these can improve your chances of reaching your financial goals.

With markets near record highs, here's what you should do with your portfolio

Markets have weathered geopolitical turmoil, hitting near record highs. Investors face tough decisions on valuations, asset concentration, and strategic portfolio rebalancing for risk control and future returns.

Latest Updates

Taxation

100 Aussies: seven charts on who earns, pays, and owns

The Labor government is talking up tax reform to lift Australia’s ailing economic growth. Before any changes are made, it’s important to know who pays tax, who owns assets, and how much people have in their super for retirement.

7 key charts on the state of the Australian property market

The Australian property market stirs fierce debate - often bullish optimism versus crash predictions. But beyond the noise, seven charts reveal what's really driving prices and the outlook for residential real estate.

A simple alternative to the $3 million super tax

Division 296 aims to introduce improved fairness into the superannuation system, yet is overly complex. This scours the world for better ideas and suggests a simpler alternative which can achieve the same goals.

CBA and the index conundrum for super funds

After the hyperbolic rise in CBA shares, super funds are floating the idea of carving out the weightings of ASX bank securities and indexing them within their portfolios. This looks at why that might be a big error.

Strategy

10 policies to drive Australian productivity higher

Here's a comprehensive list of proposed reforms to fix Australia's stagnating economy, including introducing a flat income tax rate, reducing migration, and making childcare tax-deductible.

Interviews

Where to find big winners in Asia

As more money looks for a home outside the US, Asia may soon get some love. Fidelity's Anthony Srom outlines the best places in Asia to invest, including in Chinese consumer names, Indian financials, and Thailand.

Investment strategies

We have trouble understanding the time value of money

We overvalue the present and underestimate the future - it’s a cognitive glitch called hyperbolic discounting. It affects savings, spending, and loans, and it's more common - and costly - than we think. 

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.