Shaival Reality Limited (NSEI:SHAIVAL) generated a below-average return on equity of 22.28% in the past 12 months, while its industry returned 23.22%. SHAIVAL’s results could indicate a relatively inefficient operation to its peers, and while this may be the case, it is important to understand what ROE is made up of and how it should be interpreted. Knowing these components could change your view on SHAIVAL’s performance. I will take you through how metrics such as financial leverage impact ROE which may affect the overall sustainability of SHAIVAL’s returns. Check out our latest analysis for Shaival Reality
What you must know about ROE
Return on Equity (ROE) is a measure of SHAIVAL’s profit relative to its shareholders’ equity. An ROE of 22.28% implies ₹0.22 returned on every ₹1 invested. 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 measured against cost of equity in order to determine the efficiency of SHAIVAL’s equity capital deployed. Its cost of equity is 16.42%. SHAIVAL’s ROE exceeds its cost by 5.86%, which is a big tick. Some of its peers with higher ROE may face a cost which exceeds returns, which is unsustainable and far less desirable than SHAIVAL’s case of positive discrepancy. 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
Basically, profit margin measures how much of revenue trickles down into earnings which illustrates how efficient SHAIVAL is with its cost management. The other component, asset turnover, illustrates how much revenue SHAIVAL can make from its asset base. Finally, financial leverage will be our main focus today. It shows how much of assets are funded by equity and can show how sustainable SHAIVAL’s capital structure is. Since financial leverage can artificially inflate ROE, we need to look at how much debt SHAIVAL currently has. At over 2.5 times, SHAIVAL’s debt-to-equity ratio is very high and indicates the below-average ROE is already being generated by significant leverage levels.
What this means for you:
Are you a shareholder? While SHAIVAL exhibits a weak ROE against its peers, its returns are sufficient enough to cover its cost of equity, which means its generating value for shareholders. However, with debt capital in excess of equity, ROE might be inflated by the use of debt funding, which is something you should be aware of before buying more SHAIVAL shares. If you’re looking for new ideas for high-returning stocks, you should take a look at our free platform to see the list of stocks with Return on Equity over 20%.