I am writing today to help inform people who are new to the stock market and looking to gauge the potential return on investment in Vinati Organics Limited (NSE:VINATIORGA).
Vinati Organics Limited (NSE:VINATIORGA) outperformed the Specialty Chemicals industry on the basis of its ROE – producing a higher 18.06% relative to the peer average of 13.20% over the past 12 months. While the impressive ratio tells us that VINATIORGA has made significant profits from little equity capital, ROE doesn’t tell us if VINATIORGA has borrowed debt to make this happen. Today, we’ll take a closer look at some factors like financial leverage to see how sustainable VINATIORGA’s ROE is. Check out our latest analysis for Vinati Organics
Breaking down Return on Equity
Return on Equity (ROE) is a measure of Vinati Organics’s profit relative to its shareholders’ equity. It essentially shows how much the company can generate in earnings given the amount of equity it has raised. 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
Returns are usually compared to costs to measure the efficiency of capital. Vinati Organics’s cost of equity is 13.55%. Since Vinati Organics’s return covers its cost in excess of 4.51%, its use of equity capital is efficient and likely to be sustainable. Simply put, Vinati Organics pays less for its capital than what it generates in return. ROE can be split up into three useful 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. The other component, asset turnover, illustrates how much revenue Vinati Organics can make from its asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. Since financial leverage can artificially inflate ROE, we need to look at how much debt Vinati Organics currently has. At 1.91%, Vinati Organics’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. Vinati Organics exhibits a strong ROE against its peers, as well as sufficient returns to cover its cost of equity. ROE is not likely to be inflated by excessive debt funding, giving shareholders more conviction in the sustainability of high returns. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.