What You Must Know About Bharti Airtel Limited's (NSE:BHARTIARTL) 2.61% ROE

This analysis is intended to introduce important early concepts to people who are starting to invest and want to start learning about core concepts of fundamental analysis on practical examples from today's market.

Bharti Airtel Limited (NSE:BHARTIARTL) generated a below-average return on equity of 2.61% in the past 12 months, while its industry returned 8.40%. 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 BHARTIARTL's past performance. I will take you through how metrics such as financial leverage impact ROE which may affect the overall sustainability of BHARTIARTL's returns.

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What you must know about ROE

Return on Equity (ROE) weighs Bharti Airtel’s profit against the level of its shareholders’ equity. An ROE of 2.61% implies ₹0.026 returned on every ₹1 invested, so the higher the return, the better. Investors that are diversifying their portfolio based on industry may want to maximise their return in the Wireless Telecommunication Services sector by choosing the highest returning stock. However, this can be deceiving as each company has varying costs of equity and debt levels, which could exaggeratedly push up ROE at the same time as accumulating high interest expense.

ROE is measured against cost of equity in order to determine the efficiency of Bharti Airtel’s equity capital deployed. Its cost of equity is 14.84%. Given a discrepancy of -12.24% between return and cost, this indicated that Bharti Airtel may be paying more for its capital than what it’s generating in return. ROE can be broken down into three different 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 reveals how much revenue can be generated from Bharti Airtel’s asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. 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 Bharti Airtel’s debt-to-equity ratio to examine sustainability of its returns. The most recent ratio is 151.94%, which is relatively high, indicating Bharti Airtel’s below-average ROE is already being pushed up artificially by leverage and its ability to grow profit hinges on a sizeable debt burden.

Next Steps:

ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. Bharti Airtel exhibits a weak ROE against its peers, as well as insufficient levels to cover its own cost of equity this year. Also, with debt capital in excess of equity, ROE may already be inflated by the use of debt funding, raising questions over the possibility of further decline in the company’s returns. Although ROE can be a useful metric, it is only a small part of diligent research.

For Bharti Airtel, I've put together three key aspects you should further research:

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 Bharti Airtel 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 Bharti Airtel is currently mispriced by the market.
3. Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Bharti Airtel? 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 past 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.