AXISCADES Engineering Technologies Limited (NSEI:AXISCADES) delivered a less impressive 1.98% ROE over the past year, compared to the 8.72% return generated by its industry. An investor may attribute an inferior ROE to a relatively inefficient performance, and whilst this can often be the case, knowing the nuts and bolts of the ROE calculation may change that perspective and give you a deeper insight into AXISCADES’s past performance. I will take you through how metrics such as financial leverage impact ROE which may affect the overall sustainability of AXISCADES’s returns. View our latest analysis for AXISCADES Engineering Technologies
Peeling the layers of ROE – trisecting a company’s profitability
Return on Equity (ROE) weighs AXISCADES Engineering Technologies’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
ROE is measured against cost of equity in order to determine the efficiency of AXISCADES Engineering Technologies’s equity capital deployed. Its cost of equity is 14.30%. Since AXISCADES Engineering Technologies’s return does not cover its cost, with a difference of -12.32%, this means its current use of equity is not efficient and not sustainable. Very simply, AXISCADES Engineering Technologies 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 AXISCADES Engineering Technologies’s 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 AXISCADES Engineering Technologies’s historic debt-to-equity ratio. At 54.92%, AXISCADES Engineering Technologies’s debt-to-equity ratio appears sensible and indicates its ROE is generated from its capacity to increase profit without a large debt burden.