Genus Power Infrastructures Limited (NSEI:GENUSPOWER) outperformed the Electronic Equipment and Instruments industry on the basis of its ROE – producing a higher 11.32% relative to the peer average of 10.14% over the past 12 months. On the surface, this looks fantastic since we know that GENUSPOWER has made large profits from little equity capital; however, ROE doesn’t tell us if management have borrowed heavily to make this happen. Today, we’ll take a closer look at some factors like financial leverage to see how sustainable GENUSPOWER’s ROE is. View our latest analysis for Genus Power Infrastructures
Peeling the layers of ROE – trisecting a company’s profitability
Return on Equity (ROE) weighs Genus Power Infrastructures’s profit against the level of its shareholders’ equity. For example, if the company invests ₹1 in the form of equity, it will generate ₹0.11 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. Genus Power Infrastructures’s cost of equity is 13.40%. Given a discrepancy of -2.08% between return and cost, this indicated that Genus Power Infrastructures may be paying more for its capital than what it’s generating 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. The other component, asset turnover, illustrates how much revenue Genus Power Infrastructures 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 ROE can be artificially increased through excessive borrowing, we should check Genus Power Infrastructures’s historic debt-to-equity ratio. At 31.84%, Genus Power Infrastructures’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:
While ROE is a relatively simple calculation, it can be broken down into different ratios, each telling a different story about the strengths and weaknesses of a company. Genus Power Infrastructures exhibits a strong ROE against its peers, however it was not high enough to cover its own cost of equity this year. ROE is not likely to be inflated by excessive debt funding, giving shareholders more conviction in the sustainability of industry-beating returns. Although ROE can be a useful metric, it is only a small part of diligent research.