Radaan Mediaworks India Limited’s (NSEI:RADAAN) most recent return on equity was a substandard 3.96% relative to its industry performance of 7.16% over the past year. RADAAN’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 RADAAN’s performance. I will take you through how metrics such as financial leverage impact ROE which may affect the overall sustainability of RADAAN’s returns. See our latest analysis for Radaan Mediaworks India

Breaking down Return on Equity

Return on Equity (ROE) weighs Radaan Mediaworks India’s profit against the level of its shareholders’ equity. For example, if the company invests ₹1 in the form of equity, it will generate ₹0.04 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 Radaan Mediaworks India’s equity capital deployed. Its cost of equity is 16.56%. Since Radaan Mediaworks India’s return does not cover its cost, with a difference of -12.60%, this means its current use of equity is not efficient and not sustainable. Very simply, Radaan Mediaworks India 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

Basically, profit margin measures how much of revenue trickles down into earnings which illustrates how efficient the business is with its cost management. Asset turnover shows how much revenue Radaan Mediaworks India 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 artificially increased through excessive borrowing, we should check Radaan Mediaworks India’s historic debt-to-equity ratio. Currently the debt-to-equity ratio stands at a low 42.15%, which means Radaan Mediaworks India still has headroom to take on more leverage in order to increase profits.