Chelyabinsky Plant for Profiled Metal Floor Decking Public Joint-Stock Company’s (MISX:PRFN) most recent return on equity was a substandard 0.71% relative to its industry performance of 24.78% over the past year. PRFN’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 PRFN’s performance. Today I will look at how components such as financial leverage can influence ROE which may impact the sustainability of PRFN’s returns. Check out our latest analysis for Chelyabinsky Plant for Profiled Metal Floor Decking
Breaking down Return on Equity
Firstly, Return on Equity, or ROE, is simply the percentage of last years’ earning against the book value of shareholders’ equity. For example, if the company invests RUB1 in the form of equity, it will generate RUB0.01 in earnings from this. Generally speaking, a higher ROE is preferred; however, there are other factors we must also consider before making any conclusions.
Return on Equity = Net Profit ÷ Shareholders Equity
ROE is assessed against cost of equity, which is measured using the Capital Asset Pricing Model (CAPM) – but let’s not dive into the details of that today. For now, let’s just look at the cost of equity number for Chelyabinsky Plant for Profiled Metal Floor Decking, which is 18.27%. Given a discrepancy of -17.56% between return and cost, this indicated that Chelyabinsky Plant for Profiled Metal Floor Decking 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
Essentially, profit margin shows how much money the company makes after paying for all its expenses. Asset turnover shows how much revenue Chelyabinsky Plant for Profiled Metal Floor Decking 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 Chelyabinsky Plant for Profiled Metal Floor Decking’s historic debt-to-equity ratio. The debt-to-equity ratio currently stands at a low 11.23%, meaning Chelyabinsky Plant for Profiled Metal Floor Decking still has headroom to borrow debt to increase profits.