Shyam Telecom Limited (NSEI:SHYAMTEL) outperformed the Communications Equipment industry on the basis of its ROE – producing a higher 58.62% relative to the peer average of 11.90% over the past 12 months. Superficially, this looks great since we know that SHYAMTEL has generated big profits with little equity capital; however, ROE doesn’t tell us how much SHYAMTEL has borrowed in debt. We’ll take a closer look today at factors like financial leverage to determine whether SHYAMTEL’s ROE is actually sustainable. View our latest analysis for Shyam Telecom
Breaking down ROE — the mother of all ratios
Return on Equity (ROE) weighs Shyam Telecom’s profit against the level of its shareholders’ equity. An ROE of 58.62% implies ₹0.59 returned on every ₹1 invested. Generally speaking, a higher ROE is preferred; however, there are other factors we must also consider before making any conclusions.
Return on Equity = Net Profit ÷ Shareholders Equity
Returns are usually compared to costs to measure the efficiency of capital. Shyam Telecom’s cost of equity is 15.12%. Given a positive discrepancy of 43.50% between return and cost, this indicates that Shyam Telecom pays less for its capital than what it generates in return, which is a sign of capital efficiency. 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 Shyam Telecom can make from its 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 artificially increased through excessive borrowing, we should check Shyam Telecom’s historic debt-to-equity ratio. At 2.51%, Shyam Telecom’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.
Next Steps:
ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. Shyam Telecom’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. Although ROE can be a useful metric, it is only a small part of diligent research.