Marvel Decor Limited (NSEI:MDL) delivered a less impressive 10.30% ROE over the past year, compared to the 14.73% return generated by its industry. MDL’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 MDL’s performance. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of MDL’s returns. Let me show you what I mean by this. View our latest analysis for Marvel Decor
What you must know about ROE
Return on Equity (ROE) is a measure of Marvel Decor’s profit relative to its shareholders’ equity. It essentially shows how much the company can generate in earnings given the amount of equity it has raised. 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 Marvel Decor’s equity capital deployed. Its cost of equity is 13.40%. Since Marvel Decor’s return does not cover its cost, with a difference of -3.10%, this means its current use of equity is not efficient and not sustainable. Very simply, Marvel Decor 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 Marvel Decor 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 inflated by excessive debt, we need to examine Marvel Decor’s debt-to-equity level. At 159.39%, Marvel Decor’s debt-to-equity ratio appears relatively high and indicates the below-average ROE is already being generated by significant leverage levels.
Next Steps:
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. Marvel Decor’s below-industry ROE is disappointing, furthermore, its returns were not even high enough to cover its own cost of equity. However, ROE is not likely to be inflated by excessive debt funding, giving shareholders more conviction in the sustainability of returns, which has headroom to increase further. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.