Stock Analysis

Taking A Look At Aditya Birla Fashion and Retail Limited's (NSE:ABFRL) ROE

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NSEI:ABFRL
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One of the best investments we can make is in our own knowledge and skill set. With that in mind, this article will work through how we can use Return On Equity (ROE) to better understand a business. We'll use ROE to examine Aditya Birla Fashion and Retail Limited (NSE:ABFRL), by way of a worked example.

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.

See our latest analysis for Aditya Birla Fashion and Retail

How Is ROE Calculated?

The formula for ROE is:

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

So, based on the above formula, the ROE for Aditya Birla Fashion and Retail is:

12% = ₹3.3b ÷ ₹28b (Based on the trailing twelve months to June 2022).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each ₹1 of shareholders' capital it has, the company made ₹0.12 in profit.

Does Aditya Birla Fashion and Retail Have A Good ROE?

By comparing a company's ROE with its industry average, we can get a quick measure of how good it is. The limitation of this approach is that some companies are quite different from others, even within the same industry classification. You can see in the graphic below that Aditya Birla Fashion and Retail has an ROE that is fairly close to the average for the Luxury industry (12%).

roe
NSEI:ABFRL Return on Equity September 6th 2022

So while the ROE is not exceptional, at least its acceptable. While at least the ROE is not lower than the industry, its still worth checking what role the company's debt plays as high debt levels relative to equity may also make the ROE appear high. If true, then it is more an indication of risk than the potential. To know the 2 risks we have identified for Aditya Birla Fashion and Retail visit our risks dashboard for free.

How Does Debt Impact Return On Equity?

Most companies need money -- from somewhere -- to grow their profits. The cash for investment can come from prior year profits (retained earnings), issuing new shares, or borrowing. In the case of the first and second options, the ROE will reflect this use of cash, for growth. In the latter case, the use of debt will improve the returns, but will not change the equity. That will make the ROE look better than if no debt was used.

Combining Aditya Birla Fashion and Retail's Debt And Its 12% Return On Equity

It's worth noting the high use of debt by Aditya Birla Fashion and Retail, leading to its debt to equity ratio of 1.47. Its ROE is quite low, even with the use of significant debt; that's not a good result, in our opinion. Debt does bring extra risk, so it's only really worthwhile when a company generates some decent returns from it.

Conclusion

Return on equity is useful for comparing the quality of different businesses. In our books, the highest quality companies have high return on equity, despite low debt. If two companies have the same ROE, then I would generally prefer the one with less debt.

Having said that, while ROE is a useful indicator of business quality, you'll have to look at a whole range of factors to determine the right price to buy a stock. 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. So you might want to take a peek at this data-rich interactive graph of forecasts for the company.

But note: Aditya Birla Fashion and Retail may not be the best stock to buy. So take a peek at this free list of interesting companies with high ROE and low debt.

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

Find out whether Aditya Birla Fashion and Retail 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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About NSEI:ABFRL

Aditya Birla Fashion and Retail

Aditya Birla Fashion and Retail Limited designs, manufactures, distributes, and retails fashion apparel and accessories in India and internationally.

The Snowflake is a visual investment summary with the score of each axis being calculated by 6 checks in 5 areas.

Analysis AreaScore (0-6)
Valuation1
Future Growth4
Past Performance3
Financial Health4
Dividends0

Read more about these checks in the individual report sections or in our analysis model.

Reasonable growth potential with adequate balance sheet.