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Public Joint Stock Company ALROSA-Nurba (MISX:ALNU) delivered an ROE of 125.16% over the past 12 months, which is an impressive feat relative to its industry average of 24.78% during the same period. On the surface, this looks fantastic since we know that ALNU 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 ALNU’s ROE is actually sustainable. View our latest analysis for ALROSA-Nurba
What you must know about ROE
Return on Equity (ROE) weighs ALROSA-Nurba’s profit against the level of its shareholders’ equity. For example, if the company invests RUB1 in the form of equity, it will generate RUB1.25 in earnings from this. 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 ALROSA-Nurba’s equity capital deployed. Its cost of equity is 13.41%. Since ALROSA-Nurba’s return covers its cost in excess of 111.75%, its use of equity capital is efficient and likely to be sustainable. Simply put, ALROSA-Nurba pays less 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 ALROSA-Nurba can make from its asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. Since financial leverage can artificially inflate ROE, we need to look at how much debt ALROSA-Nurba currently has. Currently, ALROSA-Nurba has no debt which means its returns are driven purely by equity capital. Therefore, the level of financial leverage has no impact on ROE, and the ratio is a representative measure of the efficiency of all its capital employed firm-wide.
Next Steps:
ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. ALROSA-Nurba exhibits a strong ROE against its peers, as well as sufficient returns to cover its cost of equity. Its high ROE is not likely to be driven by high debt. Therefore, investors may have more confidence in the sustainability of this level of returns going forward. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.