Why Bimetal Bearings Limited (BOM:505681) May Not Be As Efficient As Its Industry

This article is intended for those of you who are at the beginning of your investing journey and want a simplistic look at the return on Bimetal Bearings Limited (BOM:505681) stock.

Bimetal Bearings Limited (BOM:505681) generated a below-average return on equity of 2.49% in the past 12 months, while its industry returned 10.80%. An investor may attribute an inferior ROE to a relatively inefficient performance, and whilst this can often be the case, knowing the nuts and bolts of the ROE calculation may change that perspective and give you a deeper insight into 505681's past performance. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of 505681's returns. Let me show you what I mean by this. View out our latest analysis for Bimetal Bearings

Peeling the layers of ROE – trisecting a company’s profitability

Firstly, Return on Equity, or ROE, is simply the percentage of last years’ earning against the book value of shareholders’ equity. An ROE of 2.49% implies ₹0.025 returned on every ₹1 invested, so the higher the return, the better. Investors seeking to maximise their return in the Industrial Machinery industry may want to choose the highest returning stock. But this can be misleading as each company has different costs of equity and also varying debt levels, which could artificially push up ROE whilst accumulating high interest expense.

ROE is measured against cost of equity in order to determine the efficiency of Bimetal Bearings’s equity capital deployed. Its cost of equity is 13.55%. Given a discrepancy of -11.06% between return and cost, this indicated that Bimetal Bearings may be paying more for its capital than what it’s generating in return. ROE can be dissected into three distinct ratios: net profit margin, asset turnover, and financial leverage. This is called the Dupont Formula:

Essentially, profit margin shows how much money the company makes after paying for all its expenses. The other component, asset turnover, illustrates how much revenue Bimetal Bearings can make from its asset base. And finally, financial leverage is simply how much of assets are funded by equity, which exhibits how sustainable the company’s capital structure is. We can assess whether Bimetal Bearings is fuelling ROE by excessively raising debt. Ideally, Bimetal Bearings should have a balanced capital structure, which we can check by looking at the historic debt-to-equity ratio of the company. Currently, Bimetal Bearings has no debt which means its returns are driven purely by equity capital. This could explain why Bimetal Bearings's' ROE is lower than its industry peers, most of which may have some degree of debt in its business.

Next Steps:

ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. Bimetal Bearings’s ROE is underwhelming relative to the industry average, and its returns were also not strong enough to cover its own cost of equity. Although, its appropriate level of leverage means investors can be more confident in the sustainability of Bimetal Bearings’s return with a possible increase should the company decide to increase its debt levels. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.

For Bimetal Bearings, I've put together three relevant aspects you should further research:

1. Financial Health: Does it have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
2. Future Earnings: How does Bimetal Bearings's growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
3. Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Bimetal Bearings? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!

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Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.