Is Neogen Chemicals Limited's (NSE:NEOGEN) ROE Of 19% Impressive?

By
Simply Wall St
Published
January 05, 2022
NSEI:NEOGEN
Source: Shutterstock

One of the best investments we can make is in our own knowledge and skill set. With that in mind, this article will work through how we can use Return On Equity (ROE) to better understand a business. To keep the lesson grounded in practicality, we'll use ROE to better understand Neogen Chemicals Limited (NSE:NEOGEN).

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Neogen Chemicals

How To Calculate Return On Equity?

Return on equity can be calculated by using the formula:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Neogen Chemicals is:

19% = ₹364m ÷ ₹2.0b (Based on the trailing twelve months to September 2021).

The 'return' is the yearly profit. Another way to think of that is that for every ₹1 worth of equity, the company was able to earn ₹0.19 in profit.

Does Neogen Chemicals Have A Good ROE?

One simple way to determine if a company has a good return on equity is to compare it to the average for its industry. However, this method is only useful as a rough check, because companies do differ quite a bit within the same industry classification. As you can see in the graphic below, Neogen Chemicals has a higher ROE than the average (15%) in the Chemicals industry.

roe
NSEI:NEOGEN Return on Equity January 5th 2022

That is a good sign. With that said, a high ROE doesn't always indicate high profitability. A higher proportion of debt in a company's capital structure may also result in a high ROE, where the high debt levels could be a huge risk . You can see the 3 risks we have identified for Neogen Chemicals by visiting our risks dashboard for free on our platform here.

How Does Debt Impact ROE?

Most companies need money -- from somewhere -- to grow their profits. That cash can come from retained earnings, issuing new shares (equity), or debt. In the first two cases, the ROE will capture this use of capital to grow. In the latter case, the debt used for growth will improve returns, but won't affect the total equity. That will make the ROE look better than if no debt was used.

Combining Neogen Chemicals' Debt And Its 19% Return On Equity

It's worth noting the high use of debt by Neogen Chemicals, leading to its debt to equity ratio of 1.37. While its ROE is respectable, it is worth keeping in mind that there is usually a limit as to how much debt a company can use. Investors should think carefully about how a company might perform if it was unable to borrow so easily, because credit markets do change over time.

Conclusion

Return on equity is one way we can compare its business quality of different companies. Companies that can achieve high returns on equity without too much debt are generally of good quality. If two companies have around the same level of debt to equity, and one has a higher ROE, I'd generally prefer the one with higher ROE.

But ROE is just one piece of a bigger puzzle, since high quality businesses often trade on high multiples of earnings. It is important to consider other factors, such as future profit growth -- and how much investment is required going forward. So I think it may be worth checking this free report on analyst forecasts for the company.

Of course Neogen Chemicals may not be the best stock to buy. So you may wish to see this free collection of other companies that have high ROE and low debt.

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