Bajaj Holdings & Investment Limited (NSEI:BAJAJHLDNG) delivered an ROE of 14.80% over the past 12 months, which is an impressive feat relative to its industry average of 7.56% during the same period. Superficially, this looks great since we know that BAJAJHLDNG has generated big profits with little equity capital; however, ROE doesn’t tell us how much BAJAJHLDNG has borrowed in debt. Today, we’ll take a closer look at some factors like financial leverage to see how sustainable BAJAJHLDNG’s ROE is. Check out our latest analysis for Bajaj Holdings & Investment
Breaking down Return on Equity
Return on Equity (ROE) is a measure of Bajaj Holdings & Investment’s profit relative to its shareholders’ equity. An ROE of 14.80% implies ₹0.15 returned on every ₹1 invested. 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. Bajaj Holdings & Investment’s cost of equity is 13.40%. Since Bajaj Holdings & Investment’s return covers its cost in excess of 1.40%, its use of equity capital is efficient and likely to be sustainable. Simply put, Bajaj Holdings & Investment 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. Asset turnover shows how much revenue Bajaj Holdings & Investment 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 Bajaj Holdings & Investment’s debt-to-equity level. Currently, Bajaj Holdings & Investment 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.
What this means for you:
Are you a shareholder? BAJAJHLDNG’s above-industry ROE is encouraging, and is also in excess of its cost of equity. Since its high ROE is not likely driven by high debt, it might be a good time to top up on your current holdings if your fundamental research reaffirms this analysis. If you’re looking for new ideas for high-returning stocks, you should take a look at our free platform to see the list of stocks with Return on Equity over 20%.