Stock Analysis

Can Sundaram-Clayton Limited's (NSE:SUNCLAYLTD) ROE Continue To Surpass The Industry Average?

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NSEI:SUNCLAYLTD
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Many investors are still learning about the various metrics that can be useful when analysing a stock. This article is for those who would like to learn about Return On Equity (ROE). To keep the lesson grounded in practicality, we'll use ROE to better understand Sundaram-Clayton Limited (NSE:SUNCLAYLTD).

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out the opportunities and risks within the IN Auto Components industry.

How To Calculate Return On Equity?

The formula for return on equity is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Sundaram-Clayton is:

16% = ₹13b ÷ ₹80b (Based on the trailing twelve months to September 2022).

The 'return' is the profit over the last twelve months. So, this means that for every ₹1 of its shareholder's investments, the company generates a profit of ₹0.16.

Does Sundaram-Clayton Have A Good ROE?

Arguably the easiest way to assess company's ROE is to compare it with the average in its industry. However, this method is only useful as a rough check, because companies do differ quite a bit within the same industry classification. Pleasingly, Sundaram-Clayton has a superior ROE than the average (11%) in the Auto Components industry.

roe
NSEI:SUNCLAYLTD Return on Equity December 8th 2022

That is a good sign. However, bear in mind that a high ROE doesn’t necessarily indicate efficient profit generation. A higher proportion of debt in a company's capital structure may also result in a high ROE, where the high debt levels could be a huge risk . To know the 3 risks we have identified for Sundaram-Clayton visit our risks dashboard for free.

How Does Debt Impact Return On Equity?

Companies usually need to invest money to grow their profits. The cash for investment can come from prior year profits (retained earnings), issuing new shares, or borrowing. In the first and second cases, the ROE will reflect this use of cash for investment in the business. In the latter case, the use of debt will improve the returns, but will not change the equity. Thus the use of debt can improve ROE, albeit along with extra risk in the case of stormy weather, metaphorically speaking.

Combining Sundaram-Clayton's Debt And Its 16% Return On Equity

Sundaram-Clayton does use a high amount of debt to increase returns. It has a debt to equity ratio of 2.40. Its ROE is quite low, even with the use of significant debt; that's not a good result, in our opinion. Debt increases risk and reduces options for the company in the future, so you generally want to see some good returns from using it.

Summary

Return on equity is a useful indicator of the ability of a business to generate profits and return them to shareholders. Companies that can achieve high returns on equity without too much debt are generally of good quality. If two companies have the same ROE, then I would generally prefer the one with less debt.

But when a business is high quality, the market often bids it up to a price that reflects this. The rate at which profits are likely to grow, relative to the expectations of profit growth reflected in the current price, must be considered, too. You can see how the company has grow in the past by looking at this FREE detailed graph of past earnings, revenue and cash flow.

Of course, you might find a fantastic investment by looking elsewhere. So take a peek at this free list of interesting companies.

Valuation is complex, but we're helping make it simple.

Find out whether Sundaram-Clayton is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

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