Lypsa Gems & Jewellery Limited (NSEI:LYPSAGEMS) delivered an ROE of 25.65% over the past 12 months, which is an impressive feat relative to its industry average of 8.38% during the same period. But what is more interesting is whether LYPSAGEMS can sustain this above-average ratio. A measure of sustainable returns is LYPSAGEMS’s financial leverage. If LYPSAGEMS borrows debt to invest in its business, its profits will be higher. But ROE does not capture any debt, so we only see high profits and low equity, which is great on the surface. But today let’s take a deeper dive below this surface. See our latest analysis for Lypsa Gems & Jewellery
Breaking down Return on Equity
Return on Equity (ROE) is a measure of Lypsa Gems & Jewellery’s profit relative to its shareholders’ equity. For example, if the company invests ₹1 in the form of equity, it will generate ₹0.26 in earnings from this. If investors diversify their portfolio by industry, they may want to maximise their return in the Apparel, Accessories and Luxury Goods sector by investing in the highest returning stock. However, this can be misleading as each firm has different costs of equity and debt levels i.e. the more debt Lypsa Gems & Jewellery has, the higher ROE is pumped up in the short term, at the expense of long term interest payment burden.
Return on Equity = Net Profit ÷ Shareholders Equity
ROE is measured against cost of equity in order to determine the efficiency of Lypsa Gems & Jewellery’s equity capital deployed. Its cost of equity is 13.40%. Since Lypsa Gems & Jewellery’s return covers its cost in excess of 12.25%, its use of equity capital is efficient and likely to be sustainable. Simply put, Lypsa Gems & Jewellery pays less 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:
ROE = profit margin × asset turnover × financial leverage
ROE = (annual net profit ÷ sales) × (sales ÷ assets) × (assets ÷ shareholders’ equity)
ROE = annual net profit ÷ shareholders’ equity
The first component is profit margin, which measures how much of sales is retained after the company pays for all its expenses. Asset turnover shows how much revenue Lypsa Gems & Jewellery can generate with its current asset base. Finally, financial leverage will be our main focus today. It shows how much of assets are funded by equity and can show how sustainable the company’s capital structure is. ROE can be inflated by disproportionately high levels of debt. This is also unsustainable due to the high interest cost that the company will also incur. Thus, we should look at Lypsa Gems & Jewellery’s debt-to-equity ratio to examine sustainability of its returns. The ratio currently stands at a sensible 20.64%, meaning Lypsa Gems & Jewellery has not taken on excessive debt to drive its returns. The company is able to produce profit growth without a huge debt burden.
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. Lypsa Gems & Jewellery’s ROE is impressive relative to the industry average and also covers its cost of equity. Its high ROE is not likely to be driven by high debt. Therefore, investors may have more confidence in the sustainability of this level of returns going forward. Although ROE can be a useful metric, it is only a small part of diligent research.
For Lypsa Gems & Jewellery, I’ve compiled three essential 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 Lypsa Gems & Jewellery’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 Lypsa Gems & Jewellery? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!