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 begin learning the link between Shilpa Medicare Limited (NSE:SHILPAMED)’s return fundamentals and stock market performance.

Shilpa Medicare Limited (NSE:SHILPAMED) delivered a less impressive 9.53% ROE over the past year, compared to the 10.69% return generated by its industry. Though SHILPAMED’s recent performance is underwhelming, it is useful to understand what ROE is made up of and how it should be interpreted. Knowing these components can change your views on SHILPAMED’s below-average returns. I will take you through how metrics such as financial leverage impact ROE which may affect the overall sustainability of SHILPAMED’s returns. See our latest analysis for Shilpa Medicare

Breaking down Return on Equity

Return on Equity (ROE) weighs Shilpa Medicare’s profit against the level of its shareholders’ equity. For example, if the company invests ₹1 in the form of equity, it will generate ₹0.095 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 measured against cost of equity in order to determine the efficiency of Shilpa Medicare’s equity capital deployed. Its cost of equity is 13.55%. This means Shilpa Medicare’s returns actually do not cover its own cost of equity, with a discrepancy of -4.02%. 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 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

The first component is profit margin, which measures how much of sales is retained after the company pays for all its expenses. The other component, asset turnover, illustrates how much revenue Shilpa Medicare 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 the company’s capital structure is. Since ROE can be artificially increased through excessive borrowing, we should check Shilpa Medicare’s historic debt-to-equity ratio. At 15.40%, Shilpa Medicare’s debt-to-equity ratio appears low and indicates that Shilpa Medicare still has room to increase leverage and grow its profits.