Public Joint Stock Company Krasnoyarskenergosbyt (MISX:KRSB) outperformed the Electric Utilities industry on the basis of its ROE – producing a higher 28.92% relative to the peer average of 8.93% over the past 12 months. On the surface, this looks fantastic since we know that KRSB 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 KRSB’s ROE. View our latest analysis for Krasnoyarskenergosbyt
Peeling the layers of ROE – trisecting a company’s profitability
Return on Equity (ROE) is a measure of Krasnoyarskenergosbyt’s profit relative to its shareholders’ equity. For example, if the company invests RUB1 in the form of equity, it will generate RUB0.29 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 assessed against cost of equity, which is measured using the Capital Asset Pricing Model (CAPM) – but let’s not dive into the details of that today. For now, let’s just look at the cost of equity number for Krasnoyarskenergosbyt, which is 13.41%. Since Krasnoyarskenergosbyt’s return covers its cost in excess of 15.51%, its use of equity capital is efficient and likely to be sustainable. Simply put, Krasnoyarskenergosbyt pays less 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
The first component is profit margin, which measures how much of sales is retained after the company pays for all its expenses. Asset turnover shows how much revenue Krasnoyarskenergosbyt can generate with its current 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 ROE can be inflated by excessive debt, we need to examine Krasnoyarskenergosbyt’s debt-to-equity level. At 42.37%, Krasnoyarskenergosbyt’s debt-to-equity ratio appears low and indicates the above-average ROE is generated from its capacity to increase profit without a large debt burden.