I am writing today to help inform people who are new to the stock market and want to begin learning the link between Avanti Feeds Limited (NSE:AVANTI)’s return fundamentals and stock market performance.
With an ROE of 40.57%, Avanti Feeds Limited (NSE:AVANTI) outpaced its own industry which delivered a less exciting 9.64% over the past year. While the impressive ratio tells us that AVANTI has made significant profits from little equity capital, ROE doesn’t tell us if AVANTI has borrowed debt to make this happen. Today, we’ll take a closer look at some factors like financial leverage to see how sustainable AVANTI’s ROE is. See our latest analysis for Avanti Feeds
What you must know about ROE
Return on Equity (ROE) is a measure of Avanti Feeds’s profit relative to its shareholders’ equity. For example, if the company invests ₹1 in the form of equity, it will generate ₹0.41 in earnings from this. 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
Returns are usually compared to costs to measure the efficiency of capital. Avanti Feeds’s cost of equity is 13.55%. This means Avanti Feeds returns enough to cover its own cost of equity, with a buffer of 27.02%. 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. The other component, asset turnover, illustrates how much revenue Avanti Feeds can make from its 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 Avanti Feeds currently has. Currently Avanti Feeds has virtually no debt, which means its returns are predominantly driven 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.
Next Steps:
ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. Avanti Feeds’s ROE is impressive relative to the industry average and also covers its cost of equity. Its high ROE is not likely to be driven by high debt. Therefore, investors may have more confidence in the sustainability of this level of returns going forward. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.