Public Joint-Stock Company TNS energo Rostov-on-Don (MISX:RTSB) performed in-line with its electric utilities industry on the basis of its ROE – producing a return of11.34% relative to the peer average of 9.14% over the past 12 months. However, whether this ROE is actually impressive depends on if it can be maintained. Sustainability can be gauged by a company’s financial leverage – the more debt it has, the higher ROE is pumped up in the short term, at the expense of long term interest payment burden. Let me show you what I mean by this. Check out our latest analysis for TNS energo Rostov-on-Don
What you must know about ROE
Return on Equity (ROE) weighs TNS energo Rostov-on-Don’s profit against the level of its shareholders’ equity. An ROE of 11.34% implies RUB0.11 returned on every RUB1 invested, so the higher the return, the better. If investors diversify their portfolio by industry, they may want to maximise their return in the Electric Utilities sector by investing in the highest returning stock. However, this can be misleading as each firm has different costs of equity and debt levels i.e. the more debt TNS energo Rostov-on-Don has, the higher ROE is pumped up in the short term, at the expense of long term interest payment burden.
Return on Equity = Net Profit ÷ Shareholders Equity
ROE is measured against cost of equity in order to determine the efficiency of TNS energo Rostov-on-Don’s equity capital deployed. Its cost of equity is 9.76%. This means TNS energo Rostov-on-Don returns enough to cover its own cost of equity, with a buffer of 1.57%. This sustainable practice implies that the company pays less for its capital than what it generates in return. ROE can be split up into three useful ratios: net profit margin, asset turnover, and financial leverage. This is called the Dupont Formula:
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
Basically, profit margin measures how much of revenue trickles down into earnings which illustrates how efficient the business is with its cost management. The other component, asset turnover, illustrates how much revenue TNS energo Rostov-on-Don can make from its 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. We can assess whether TNS energo Rostov-on-Don is fuelling ROE by excessively raising debt. Ideally, TNS energo Rostov-on-Don should have a balanced capital structure, which we can check by looking at the historic debt-to-equity ratio of the company. Currently the ratio stands at more than 2.5 times, which is very high. This means TNS energo Rostov-on-Don’s above-average ROE is being driven by its significant debt levels and its ability to grow profit hinges on a significant debt burden.
Next Steps:
ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. TNS energo Rostov-on-Don’s above-industry ROE is encouraging, and is also in excess of its cost of equity. With debt capital in excess of equity, ROE may be inflated by the use of debt funding, raising questions over the sustainability of the company’s returns. Although ROE can be a useful metric, it is only a small part of diligent research.
For TNS energo Rostov-on-Don, I’ve compiled three fundamental factors 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 TNS energo Rostov-on-Don 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 TNS energo Rostov-on-Don is currently mispriced by the market.
- 3. Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of TNS energo Rostov-on-Don? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!