Based On Its ROE, Is National Fertilizers Limited (NSE:NFL) A High Quality Stock?

Many investors are still learning about the various metrics that can be useful when analysing a stock. This article is for those who would like to learn about Return On Equity (ROE). We'll use ROE to examine National Fertilizers Limited (NSE:NFL), by way of a worked example.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

Check out our latest analysis for National Fertilizers

How Do You 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 National Fertilizers is:

5.9% = ₹1.5b ÷ ₹26b (Based on the trailing twelve months to March 2024).

The 'return' is the income the business earned over the last year. That means that for every ₹1 worth of shareholders' equity, the company generated ₹0.06 in profit.

Does National Fertilizers Have A Good ROE?

By comparing a company's ROE with its industry average, we can get a quick measure of how good it is. The limitation of this approach is that some companies are quite different from others, even within the same industry classification. If you look at the image below, you can see National Fertilizers has a lower ROE than the average (10%) in the Chemicals industry classification.

Unfortunately, that's sub-optimal. Although, we think that a lower ROE could still mean that a company has the opportunity to better its returns with the use of leverage, provided its existing debt levels are low. A company with high debt levels and low ROE is a combination we like to avoid given the risk involved. You can see the 4 risks we have identified for National Fertilizers by visiting our risks dashboard for free on our platform here.

The Importance Of Debt To Return On Equity

Virtually all companies need money to invest in the business, to grow profits. That cash can come from retained earnings, issuing new shares (equity), or debt. In the case of the first and second options, the ROE will reflect this use of cash, for growth. In the latter case, the use of debt will improve the returns, but will not change the equity. In this manner the use of debt will boost ROE, even though the core economics of the business stay the same.

National Fertilizers' Debt And Its 5.9% ROE

It's worth noting the high use of debt by National Fertilizers, leading to its debt to equity ratio of 1.60. Its ROE is quite low, even with the use of significant debt; that's not a good result, in our opinion. 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.

Summary

Return on equity is useful for comparing the quality of different businesses. A company that can achieve a high return on equity without debt could be considered a high quality business. If two companies have the same ROE, then I would generally prefer the one with less debt.

But when a business is high quality, the market often bids it up to a price that reflects this. The rate at which profits are likely to grow, relative to the expectations of profit growth reflected in the current price, must be considered, too. You can see how the company has grow in the past by looking at this FREE detailed graph of past earnings, revenue and cash flow.

If you would prefer check out another company -- one with potentially superior financials -- then do not miss this free list of interesting companies, that have HIGH return on equity and low debt.

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This article by Simply Wall St 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. Simply Wall St has no position in any stocks mentioned.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com