Will Tainwala Chemicals and Plastics (India) Limited (NSE:TAINWALCHM) Continue To Underperform Its Industry?

The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to learn about Return on Equity using a real-life example.

Tainwala Chemicals and Plastics (India) Limited’s (NSE:TAINWALCHM) most recent return on equity was a substandard 8.44% relative to its industry performance of 13.36% over the past year. Though TAINWALCHM's recent performance is underwhelming, it is useful to understand what ROE is made up of and how it should be interpreted. Knowing these components can change your views on TAINWALCHM's below-average returns. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of TAINWALCHM's returns. Let me show you what I mean by this.

Check out our latest analysis for Tainwala Chemicals and Plastics (India)

What you must know about ROE

Return on Equity (ROE) is a measure of Tainwala Chemicals and Plastics (India)’s profit relative to its shareholders’ equity. It essentially shows how much the company can generate in earnings given the amount of equity it has raised. Investors seeking to maximise their return in the Commodity Chemicals industry may want to choose 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.

Returns are usually compared to costs to measure the efficiency of capital. Tainwala Chemicals and Plastics (India)’s cost of equity is 13.55%. This means Tainwala Chemicals and Plastics (India)’s returns actually do not cover its own cost of equity, with a discrepancy of -5.11%. 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 dissected into three distinct ratios: net profit margin, asset turnover, and financial leverage. This is called the Dupont Formula:

The first component is profit margin, which measures how much of sales is retained after the company pays for all its expenses. Asset turnover shows how much revenue Tainwala Chemicals and Plastics (India) can generate with its current asset base. And finally, financial leverage is simply how much of assets are funded by equity, which exhibits 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 Tainwala Chemicals and Plastics (India)’s debt-to-equity ratio to examine sustainability of its returns. Currently, Tainwala Chemicals and Plastics (India) has no debt which means its returns are driven purely by equity capital. This could explain why Tainwala Chemicals and Plastics (India)'s' ROE is lower than its industry peers, most of which may have some degree of debt in its business.

Next Steps:

ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. Tainwala Chemicals and Plastics (India) exhibits a weak ROE against its peers, as well as insufficient levels to cover its own cost of equity this year. Although, its appropriate level of leverage means investors can be more confident in the sustainability of Tainwala Chemicals and Plastics (India)’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 Tainwala Chemicals and Plastics (India), I've put together three fundamental 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. Valuation: What is Tainwala Chemicals and Plastics (India) 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 Tainwala Chemicals and Plastics (India) is currently mispriced by the market.
3. Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Tainwala Chemicals and Plastics (India)? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!

To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.

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.