GIR Natureview Resorts Limited (NSEI:GIRRESORTS) generated a below-average return on equity of 1.56% in the past 12 months, while its industry returned 9.60%. GIRRESORTS’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 GIRRESORTS’s performance. Today I will look at how components such as financial leverage can influence ROE which may impact the sustainability of GIRRESORTS’s returns. See our latest analysis for GIR Natureview Resorts
Breaking down ROE — the mother of all ratios
Return on Equity (ROE) weighs GIR Natureview Resorts’s profit against the level of its shareholders’ equity. For example, if the company invests ₹1 in the form of equity, it will generate ₹0.02 in earnings from this. If investors diversify their portfolio by industry, they may want to maximise their return in the Diversified Support Services sector by investing in 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.
Return on Equity = Net Profit ÷ Shareholders Equity
ROE is measured against cost of equity in order to determine the efficiency of GIR Natureview Resorts’s equity capital deployed. Its cost of equity is 13.40%. This means GIR Natureview Resorts’s returns actually do not cover its own cost of equity, with a discrepancy of -11.84%. 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 dissected into three distinct ratios: net profit margin, asset turnover, and financial leverage. This is called the 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. The other component, asset turnover, illustrates how much revenue GIR Natureview Resorts 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 determine if GIR Natureview Resorts’s ROE is inflated by borrowing high levels of debt. Generally, a balanced capital structure means its returns will be sustainable over the long run. We can examine this by looking at GIR Natureview Resorts’s debt-to-equity ratio. Currently, GIR Natureview Resorts has no debt which means its returns are driven purely by equity capital. This could explain why GIR Natureview Resorts’s’ ROE is lower than its industry peers, most of which may have some degree of debt in its business.
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. GIR Natureview Resorts’s ROE is underwhelming relative to the industry average, and its returns were also not strong enough to cover its own cost of equity. However, ROE is not likely to be inflated by excessive debt funding, giving shareholders more conviction in the sustainability of returns, which has headroom to increase further. Although ROE can be a useful metric, it is only a small part of diligent research.
For GIR Natureview Resorts, I’ve compiled three key factors you should further examine:
- 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 GIR Natureview Resorts’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 GIR Natureview Resorts? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!