Stock Analysis

Gillette India Limited (NSE:GILLETTE) Delivered A Better ROE Than The Industry, Here’s Why

NSEI:GILLETTE
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Gillette India Limited (NSEI:GILLETTE) delivered an ROE of 45.89% over the past 12 months, which is an impressive feat relative to its industry average of 26.14% during the same period. But what is more interesting is whether GILLETTE can sustain this above-average ratio. A measure of sustainable returns is GILLETTE’s financial leverage. If GILLETTE 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 Gillette India

Breaking down ROE — the mother of all ratios

Firstly, Return on Equity, or ROE, is simply the percentage of last years’ earning against the book value of shareholders’ equity. For example, if the company invests ₹1 in the form of equity, it will generate ₹0.46 in earnings from this. Investors that are diversifying their portfolio based on industry may want to maximise their return in the Personal Products sector by choosing 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

Returns are usually compared to costs to measure the efficiency of capital. Gillette India’s cost of equity is 13.40%. Given a positive discrepancy of 32.49% between return and cost, this indicates that Gillette India pays less for its capital than what it generates in return, which is a sign of capital efficiency. ROE can be broken down into three different 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

NSEI:GILLETTE Last Perf Mar 22nd 18
NSEI:GILLETTE Last Perf Mar 22nd 18

The first component is profit margin, which measures how much of sales is retained after the company pays for all its expenses. The other component, asset turnover, illustrates how much revenue Gillette India can make from its asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. We can determine if Gillette 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 Gillette India’s debt-to-equity ratio. Currently, Gillette India has no debt which means its returns are driven purely by equity capital. Therefore, the level of financial leverage has no impact on ROE, and the ratio is a representative measure of the efficiency of all its capital employed firm-wide.

NSEI:GILLETTE Historical Debt Mar 22nd 18
NSEI:GILLETTE Historical Debt Mar 22nd 18

Next Steps:

ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. Gillette India exhibits a strong ROE against its peers, as well as sufficient returns to cover its cost of equity. ROE is not likely to be inflated by excessive debt funding, giving shareholders more conviction in the sustainability of high returns. Although ROE can be a useful metric, it is only a small part of diligent research.

For Gillette India, I've put together three fundamental aspects you should further examine:

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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.