Stock Analysis

Boasting A 50% Return On Equity, Is Adani Power Limited (NSE:ADANIPOWER) A Top Quality Stock?

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NSEI:ADANIPOWER
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While some investors are already well versed in financial metrics (hat tip), this article is for those who would like to learn about Return On Equity (ROE) and why it is important. We'll use ROE to examine Adani Power Limited (NSE:ADANIPOWER), by way of a worked example.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for Adani Power

How To Calculate Return On Equity?

ROE 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 Adani Power is:

50% = ₹94b ÷ ₹187b (Based on the trailing twelve months to June 2022).

The 'return' is the income the business earned over the last year. Another way to think of that is that for every ₹1 worth of equity, the company was able to earn ₹0.50 in profit.

Does Adani Power 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. As is clear from the image below, Adani Power has a better ROE than the average (11%) in the Renewable Energy industry.

roe
NSEI:ADANIPOWER Return on Equity September 11th 2022

That's what we like to see. With that said, a high ROE doesn't always indicate high profitability. Aside from changes in net income, a high ROE can also be the outcome of high debt relative to equity, which indicates risk.

The Importance Of Debt To Return On Equity

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. In this manner the use of debt will boost ROE, even though the core economics of the business stay the same.

Adani Power's Debt And Its 50% ROE

Adani Power clearly uses a high amount of debt to boost returns, as it has a debt to equity ratio of 2.61. There's no doubt the ROE is impressive, but it's worth keeping in mind that the metric could have been lower if the company were to reduce its debt. Debt increases risk and reduces options for the company in the future, so you generally want to see some good returns from using it.

Conclusion

Return on equity is a useful indicator of the ability of a business to generate profits and return them to shareholders. Companies that can achieve high returns on equity without too much debt are generally of good quality. All else being equal, a higher ROE is better.

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. Check the past profit growth by Adani Power by looking at this visualization 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.

Valuation is complex, but we're helping make it simple.

Find out whether Adani Power is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

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About NSEI:ADANIPOWER

Adani Power

Adani Power Limited engages in the generation, transmission, and sale of electricity under long term power purchase agreements (PPA), medium and short term PPA, and on merchant basis in India.

The Snowflake is a visual investment summary with the score of each axis being calculated by 6 checks in 5 areas.

Analysis AreaScore (0-6)
Valuation1
Future Growth0
Past Performance3
Financial Health4
Dividends0

Read more about these checks in the individual report sections or in our analysis model.

Adequate balance sheet with acceptable track record.