This analysis is intended to introduce important early concepts to people who are starting to invest and want a simplistic look at the return on Shilpa Medicare Limited (BOM:530549) stock.
Shilpa Medicare Limited (BOM:530549) performed in line with its pharmaceuticals industry on the basis of its ROE – producing a return of 9.53% relative to the peer average of 10.68% over the past 12 months. But what is more interesting is whether 530549 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 530549's returns. Let me show you what I mean by this. View out our latest analysis for Shilpa Medicare
Breaking down Return on Equity
Return on Equity (ROE) weighs Shilpa Medicare’s profit against the level of its shareholders’ equity. For example, if the company invests ₹1 in the form of equity, it will generate ₹0.095 in earnings from this. If investors diversify their portfolio by industry, they may want to maximise their return in the Pharmaceuticals sector by investing in 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.
Return on Equity = Net Profit ÷ Shareholders Equity
Returns are usually compared to costs to measure the efficiency of capital. Shilpa Medicare’s cost of equity is 13.55%. Given a discrepancy of -4.02% between return and cost, this indicated that Shilpa Medicare may be paying more for its capital than what it’s generating in return. ROE can be dissected into three distinct 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
Essentially, profit margin shows how much money the company makes after paying for all its expenses. The other component, asset turnover, illustrates how much revenue Shilpa Medicare can make from its asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. We can assess whether Shilpa Medicare is fuelling ROE by excessively raising debt. Ideally, Shilpa Medicare should have a balanced capital structure, which we can check by looking at the historic debt-to-equity ratio of the company. The most recent ratio is 15.40%, which is sensible and indicates Shilpa Medicare has not taken on too much leverage. Thus, we can conclude its below-average ROE may be a result of low debt, and Shilpa Medicare still has room to increase leverage and grow future returns.
ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. Shilpa Medicare’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 Shilpa Medicare’s return with a possible increase should the company decide to increase its debt levels. Although ROE can be a useful metric, it is only a small part of diligent research.
For Shilpa Medicare, there are three relevant aspects you should look at:
- 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 Shilpa Medicare 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 Shilpa Medicare is currently mispriced by the market.
- Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Shilpa Medicare? 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 has no position in any of the companies mentioned. This article is general in nature. 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.
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