MMTC Limited’s (NSEI:MMTC) most recent return on equity was a substandard -2.41% relative to its industry performance of 5.04% over the past year. MMTC’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 MMTC’s performance. 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. View our latest analysis for MMTC
Breaking down Return on Equity
Return on Equity (ROE) is a measure of MMTC’s profit relative to its shareholders’ equity. It essentially shows how much MMTC 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
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 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 MMTC is with its cost management. 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 financial leverage can artificially inflate ROE, we need to look at how much debt MMTC currently has. 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 exhibits a weak ROE against its peers, as well as insufficient levels to cover its own cost of equity this year. 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%.