I am writing today to help inform people who are new to the stock market and want to better understand how you can grow your money by investing in Vindhya Telelinks Limited (NSE:VINDHYATEL).

Vindhya Telelinks Limited (NSE:VINDHYATEL) delivered a less impressive 7.32% ROE over the past year, compared to the 12.19% return generated by its industry. Though VINDHYATEL’s recent performance is underwhelming, it is useful to understand what ROE is made up of and how it should be interpreted. Knowing these components can change your views on VINDHYATEL’s below-average returns. Today I will look at how components such as financial leverage can influence ROE which may impact the sustainability of VINDHYATEL’s returns. Check out our latest analysis for Vindhya Telelinks

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

Return on Equity (ROE) weighs Vindhya Telelinks’s profit against the level of its shareholders’ equity. It essentially shows how much the company can generate in earnings given the amount of equity it has raised. 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. Vindhya Telelinks’s cost of equity is 17.00%. This means Vindhya Telelinks’s returns actually do not cover its own cost of equity, with a discrepancy of -9.68%. This isn’t sustainable as it implies, very simply, that the company 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 Vindhya Telelinks can generate with its current asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. Since ROE can be artificially increased through excessive borrowing, we should check Vindhya Telelinks’s historic debt-to-equity ratio. The debt-to-equity ratio currently stands at a low 21.91%, meaning Vindhya Telelinks still has headroom to borrow debt to increase profits.