Why Eveready Industries India Limited’s (BOM:531508) ROE Of 15.51% Does Not Tell The Whole Story

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 Eveready Industries India Limited (BOM:531508) stock.

Eveready Industries India Limited (BOM:531508) delivered an ROE of 15.51% over the past 12 months, which is relatively in-line with its industry average of 15.83% during the same period. But what is more interesting is whether 531508 can sustain or improve on this level of return. I will take you through how metrics such as financial leverage impact ROE which may affect the overall sustainability of 531508’s returns. Check out our latest analysis for Eveready Industries India

Breaking down Return on Equity

Firstly, Return on Equity, or ROE, is simply the percentage of last years’ earning against the book value of shareholders’ equity. An ROE of 15.51% implies ₹0.16 returned on every ₹1 invested, so the higher the return, the better. Investors that are diversifying their portfolio based on industry may want to maximise their return in the Household Products sector by choosing the highest returning stock. However, this can be deceiving as each company has varying costs of equity and debt levels, which could exaggeratedly push up ROE at the same time as 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 Eveready Industries India’s equity capital deployed. Its cost of equity is 13.55%. Eveready Industries India’s ROE exceeds its cost by 1.97%, which is a big tick. Some of its peers with higher ROE may face a cost which exceeds returns, which is unsustainable and far less desirable than Eveready Industries India’s case of positive discrepancy. ROE can be dissected into three distinct ratios: net profit margin, asset turnover, and financial leverage. This is called the Dupont Formula:

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

BSE:531508 Last Perf June 11th 18
BSE:531508 Last Perf June 11th 18

Basically, profit margin measures how much of revenue trickles down into earnings which illustrates how efficient the business is with its cost management. Asset turnover reveals how much revenue can be generated from Eveready Industries India’s 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 Eveready Industries India’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 Eveready Industries India’s debt-to-equity ratio. Currently the ratio stands at 60.33%, which is reasonable. This means Eveready Industries India has not taken on too much leverage, and its current ROE is driven by its ability to grow its profit without a huge debt burden.

BSE:531508 Historical Debt June 11th 18
BSE:531508 Historical Debt June 11th 18

Next Steps:

While ROE is a relatively simple calculation, it can be broken down into different ratios, each telling a different story about the strengths and weaknesses of a company. Even though Eveready Industries India returned below the industry average, its ROE comes in excess of its cost of equity. Also, 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. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.

For Eveready Industries India, I’ve put together three essential 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. Valuation: What is Eveready Industries India worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether Eveready Industries India is currently mispriced by the market.
  3. Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Eveready Industries India? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!