I am writing today to help inform people who are new to the stock market and want to begin learning the link between AVT Natural Products Limited (NSE:AVTNPL)’s return fundamentals and stock market performance.
AVT Natural Products Limited (NSE:AVTNPL) delivered an ROE of 10.16% over the past 12 months, which is an impressive feat relative to its industry average of 9.65% during the same period. On the surface, this looks fantastic since we know that AVTNPL has made large profits from little equity capital; however, ROE doesn’t tell us if management have borrowed heavily to make this happen. We’ll take a closer look today at factors like financial leverage to determine whether AVTNPL’s ROE is actually sustainable. View out our latest analysis for AVT Natural Products
What you must know about ROE
Firstly, Return on Equity, or ROE, is simply the percentage of last years’ earning against the book value of shareholders’ equity. An ROE of 10.16% implies ₹0.10 returned on every ₹1 invested. Generally speaking, a higher ROE is preferred; however, there are other factors we must also consider before making any conclusions.
Return on Equity = Net Profit ÷ Shareholders Equity
ROE is measured against cost of equity in order to determine the efficiency of AVT Natural Products’s equity capital deployed. Its cost of equity is 13.55%. This means AVT Natural Products’s returns actually do not cover its own cost of equity, with a discrepancy of -3.39%. 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
Essentially, profit margin shows how much money the company makes after paying for all its expenses. The other component, asset turnover, illustrates how much revenue AVT Natural Products can make from its 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 AVT Natural Products’s debt-to-equity level. At 15.13%, AVT Natural Products’s debt-to-equity ratio appears low and indicates the above-average ROE is generated from its capacity to increase profit without a large debt burden.
Next Steps:
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. AVT Natural Products’s above-industry ROE is noteworthy, but it was not high enough to cover its own cost of equity. ROE is not likely to be inflated by excessive debt funding, giving shareholders more conviction in the sustainability of industry-beating returns. Although ROE can be a useful metric, it is only a small part of diligent research.