Infibeam Incorporation Limited’s (NSEI:INFIBEAM) most recent return on equity was a substandard 4.09% relative to its industry performance of 7.26% over the past year. INFIBEAM’s results could indicate a relatively inefficient operation to its peers, and while this may be the case, it is important to understand what ROE is made up of and how it should be interpreted. Knowing these components could change your view on INFIBEAM’s performance. Today I will look at how components such as financial leverage can influence ROE which may impact the sustainability of INFIBEAM’s returns. View our latest analysis for Infibeam Incorporation
Breaking down ROE — the mother of all ratios
Return on Equity (ROE) weighs Infibeam Incorporation’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. 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
ROE is measured against cost of equity in order to determine the efficiency of Infibeam Incorporation’s equity capital deployed. Its cost of equity is 14.17%. Since Infibeam Incorporation’s return does not cover its cost, with a difference of -10.08%, this means its current use of equity is not efficient and not sustainable. Very simply, Infibeam Incorporation 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 reveals how much revenue can be generated from Infibeam Incorporation’s 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 Infibeam Incorporation’s debt-to-equity level. At 1.18%, Infibeam Incorporation’s debt-to-equity ratio appears low and indicates that Infibeam Incorporation still has room to increase leverage and grow its profits.