Will Century Extrusions Limited (NSE:CENTEXT) Continue To Underperform Its Industry?

I am writing today to help inform people who are new to the stock market and want to start learning about core concepts of fundamental analysis on practical examples from today's market.

Century Extrusions Limited (NSE:CENTEXT) delivered an ROE of 8.67% over the past 12 months, which is relatively in-line with its industry average of 11.02% during the same period. But what is more interesting is whether CENTEXT can sustain or improve on this level of return. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of CENTEXT's returns. Let me show you what I mean by this.

View our latest analysis for Century Extrusions

Peeling the layers of ROE – trisecting a company’s profitability

Return on Equity (ROE) weighs Century Extrusions’s profit against the level of its shareholders’ equity. An ROE of 8.67% implies ₹0.087 returned on every ₹1 invested, so the higher the return, the better. If investors diversify their portfolio by industry, they may want to maximise their return in the Aluminum 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 Century Extrusions has, the higher ROE is pumped up in the short term, at the expense of long term interest payment burden.

ROE is assessed against cost of equity, which is measured using the Capital Asset Pricing Model (CAPM) – but let’s not dive into the details of that today. For now, let’s just look at the cost of equity number for Century Extrusions, which is 17.32%. Since Century Extrusions’s return does not cover its cost, with a difference of -8.65%, this means its current use of equity is not efficient and not sustainable. Very simply, Century Extrusions pays more for its capital than what it generates in return. ROE can be split up into three useful ratios: net profit margin, asset turnover, and financial leverage. This is called the Dupont Formula:

Essentially, profit margin shows how much money the company makes after paying for all its expenses. Asset turnover reveals how much revenue can be generated from Century Extrusions’s asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. We can determine if Century Extrusions’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 Century Extrusions’s debt-to-equity ratio. The most recent ratio is 90.16%, which is relatively proportionate and indicates Century Extrusions has not taken on extreme leverage. Thus, we can conclude its current ROE is generated from its capacity to increase profit without a massive debt burden.

Next Steps:

ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. Century Extrusions’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 Century Extrusions, I've put together three important factors you should look at:

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 Century Extrusions'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 Century Extrusions? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!

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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.