Public Joint Stock Company Saratov Oil Refinery (MISX:KRKN) outperformed the Oil and Gas Refining and Marketing industry on the basis of its ROE – producing a higher 18.67% relative to the peer average of 13.82% over the past 12 months. Superficially, this looks great since we know that KRKN has generated big profits with little equity capital; however, ROE doesn’t tell us how much KRKN has borrowed in debt. We’ll take a closer look today at factors like financial leverage to determine whether KRKN’s ROE is actually sustainable. Check out our latest analysis for Saratov Oil Refinery

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

Return on Equity (ROE) weighs Saratov Oil Refinery’s profit against the level of its shareholders’ equity. An ROE of 18.67% implies RUB0.19 returned on every RUB1 invested. 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 Saratov Oil Refinery’s equity capital deployed. Its cost of equity is 13.41%. This means Saratov Oil Refinery returns enough to cover its own cost of equity, with a buffer of 5.26%. This sustainable practice implies that the company 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

Essentially, profit margin shows how much money the company makes after paying for all its expenses. Asset turnover shows how much revenue Saratov Oil Refinery can generate with its current 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 Saratov Oil Refinery’s debt-to-equity level. Currently, Saratov Oil Refinery 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.