MMTC Limited (NSEI:MMTC) delivered a less impressive -2.41% ROE over the past year, compared to the 5.04% return generated by its industry. Though MMTC’s recent performance is underwhelming, it is useful to understand what ROE is made up of and how it should be interpreted. Knowing these components can change your views on MMTC’s below-average returns. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of MMTC’s returns. Let me show you what I mean by this. Check out our latest analysis for MMTC
What you must know about ROE
Return on Equity (ROE) weighs MMTC’s profit against the level of its shareholders’ equity. An ROE of -2.41% implies ₹-0.02 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
Returns are usually compared to costs to measure the efficiency of capital. MMTC’s cost of equity is 16.76%. Since MMTC’s return does not cover its cost, with a difference of -19.18%, this means its current use of equity is not efficient and not sustainable. Very simply, MMTC pays more for its capital than what it generates in return. ROE can be split up into three useful 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 MMTC’s asset base. And finally, financial leverage is simply how much of assets are funded by equity, which exhibits how sustainable MMTC’s capital structure is. Since ROE can be inflated by excessive debt, we need to examine MMTC’s debt-to-equity level. The debt-to-equity ratio currently stands at a low 36.66%, meaning MMTC still has headroom to borrow debt to increase profits.
What this means for you:
Are you a shareholder? MMTC’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 MMTC 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%.