This article is intended for those of you who are at the beginning of your investing journey and want to begin learning the link between National Steel and Agro Industries Limited (NSE:NATNLSTEEL)’s return fundamentals and stock market performance.
National Steel and Agro Industries Limited’s (NSE:NATNLSTEEL) most recent return on equity was a substandard 7.31% relative to its industry performance of 11.09% over the past year. An investor may attribute an inferior ROE to a relatively inefficient performance, and whilst this can often be the case, knowing the nuts and bolts of the ROE calculation may change that perspective and give you a deeper insight into NATNLSTEEL’s past performance. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of NATNLSTEEL’s returns. Let me show you what I mean by this. Check out our latest analysis for National Steel and Agro Industries
Peeling the layers of ROE – trisecting a company’s profitability
Return on Equity (ROE) is a measure of National Steel and Agro Industries’s profit relative to its shareholders’ equity. For example, if the company invests ₹1 in the form of equity, it will generate ₹0.073 in earnings from this. If investors diversify their portfolio by industry, they may want to maximise their return in the Steel 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 National Steel and Agro Industries 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 National Steel and Agro Industries’s equity capital deployed. Its cost of equity is 22.27%. This means National Steel and Agro Industries’s returns actually do not cover its own cost of equity, with a discrepancy of -14.96%. This isn’t sustainable as it implies, very simply, that the company 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:
ROE = profit margin × asset turnover × financial leverage
ROE = (annual net profit ÷ sales) × (sales ÷ assets) × (assets ÷ shareholders’ equity)
ROE = annual net profit ÷ shareholders’ equity
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 shows how much revenue National Steel and Agro Industries 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 National Steel and Agro Industries’s debt-to-equity ratio to examine sustainability of its returns. The ratio currently stands at a sensible 68.09%, meaning National Steel and Agro Industries 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. National Steel and Agro Industries’s below-industry ROE is disappointing, furthermore, its returns were not even high enough to cover its own cost of equity. Although, its appropriate level of leverage means investors can be more confident in the sustainability of National Steel and Agro Industries’s return with a possible increase should the company decide to increase its debt levels. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.
For National Steel and Agro Industries, I’ve compiled three relevant factors you should further research:
- 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.
- Valuation: What is National Steel and Agro Industries 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 National Steel and Agro Industries is currently mispriced by the market.
- Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of National Steel and Agro Industries? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!