With an ROE of 13.83%, Public Joint Stock Company Kuzbasskaya Toplivnaya Company (MISX:KBTK) outpaced its own industry which delivered a less exciting 13.82% over the past year. On the surface, this looks fantastic since we know that KBTK 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 KBTK’s ROE. View our latest analysis for Kuzbasskaya Toplivnaya

Peeling the layers of ROE – trisecting a company’s profitability

Return on Equity (ROE) is a measure of Kuzbasskaya Toplivnaya’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. In most cases, a higher ROE is preferred; however, there are many other factors we must consider prior to making any investment decisions.

Return on Equity = Net Profit ÷ Shareholders Equity

ROE is measured against cost of equity in order to determine the efficiency of Kuzbasskaya Toplivnaya’s equity capital deployed. Its cost of equity is 13.41%. This means Kuzbasskaya Toplivnaya returns enough to cover its own cost of equity, with a buffer of 0.42%. This sustainable practice implies that the company pays less for its capital than what it generates in return. ROE can be split up into three useful 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. Asset turnover reveals how much revenue can be generated from Kuzbasskaya Toplivnaya’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 financial leverage can artificially inflate ROE, we need to look at how much debt Kuzbasskaya Toplivnaya currently has. At 110.93%, Kuzbasskaya Toplivnaya’s debt-to-equity ratio appears balanced and indicates the above-average ROE is generated from its capacity to increase profit without a large debt burden.