IMP Powers Limited’s (NSEI:INDLMETER) most recent return on equity was a substandard 0.72% relative to its industry performance of 8.29% over the past year. INDLMETER’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 INDLMETER’s performance. Today I will look at how components such as financial leverage can influence ROE which may impact the sustainability of INDLMETER’s returns. Check out our latest analysis for IMP Powers
Breaking down Return on Equity
Return on Equity (ROE) weighs IMP Powers’s profit against the level of its shareholders’ equity. An ROE of 0.72% implies ₹0.01 returned on every ₹1 invested. 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 measured against cost of equity in order to determine the efficiency of IMP Powers’s equity capital deployed. Its cost of equity is 21.55%. This means IMP Powers’s returns actually do not cover its own cost of equity, with a discrepancy of -20.83%. This isn’t sustainable as it implies, very simply, that the company 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
Essentially, profit margin shows how much money the company makes after paying for all its expenses. Asset turnover reveals how much revenue can be generated from IMP Powers’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 IMP Powers’s debt-to-equity level. At 101.65%, IMP Powers’s debt-to-equity ratio appears balanced and indicates its ROE is generated from its capacity to increase profit without a large debt burden.
What this means for you:
Are you a shareholder? INDLMETER’s ROE is underwhelming relative to the industry average, and its returns were also not strong enough to cover its own cost of equity. Since its existing ROE is not fuelled by unsustainable debt, investors shouldn’t give up as INDLMETER still has capacity to improve shareholder returns by borrowing to invest in new projects in the future. 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%.