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The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to better understand how you can grow your money by investing in Cochin Shipyard Limited (NSE:COCHINSHIP).
Cochin Shipyard Limited (NSE:COCHINSHIP) outperformed the Construction Machinery and Heavy Trucks industry on the basis of its ROE – producing a higher 12.15% relative to the peer average of 10.80% over the past 12 months. On the surface, this looks fantastic since we know that COCHINSHIP has made large profits from little equity capital; however, ROE doesn’t tell us if management have borrowed heavily to make this happen. In this article, we’ll closely examine some factors like financial leverage to evaluate the sustainability of COCHINSHIP’s ROE. View out our latest analysis for Cochin Shipyard
What you must know about ROE
Return on Equity (ROE) weighs Cochin Shipyard’s profit against the level of its shareholders’ equity. For example, if the company invests ₹1 in the form of equity, it will generate ₹0.12 in earnings from this. While a higher ROE is preferred in most cases, there are several other factors we should consider before drawing any conclusions.
Return on Equity = Net Profit ÷ Shareholders Equity
ROE is assessed against cost of equity, which is measured using the Capital Asset Pricing Model (CAPM) – but let’s not dive into the details of that today. For now, let’s just look at the cost of equity number for Cochin Shipyard, which is 13.55%. Given a discrepancy of -1.39% between return and cost, this indicated that Cochin Shipyard may be paying more for its capital than what it’s generating in return. ROE can be dissected into three distinct 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. Asset turnover reveals how much revenue can be generated from Cochin Shipyard’s asset base. And finally, financial leverage is simply how much of assets are funded by equity, which exhibits how sustainable the company’s capital structure is. Since ROE can be artificially increased through excessive borrowing, we should check Cochin Shipyard’s historic debt-to-equity ratio. The debt-to-equity ratio currently stands at a low 3.77%, meaning the above-average ROE is due to its capacity to produce profit growth without a huge debt burden.