This article is intended for those of you who are at the beginning of your investing journey and looking to gauge the potential return on investment in Public Joint-Stock Company TNS energo Rostov-on-Don (MCX:RTSB).
Public Joint-Stock Company TNS energo Rostov-on-Don (MCX:RTSB) outperformed the electric utilities industry on the basis of its ROE – producing a higher 15.58% relative to the peer average of 10.14% over the past 12 months. But what is more interesting is whether RTSB can sustain this above-average ratio. 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. View out our latest analysis for TNS energo Rostov-on-Don
What you must know about ROE
Firstly, Return on Equity, or ROE, is simply the percentage of last years’ earning against the book value of shareholders’ equity. For example, if the company invests RUB1 in the form of equity, it will generate RUB0.16 in earnings from this. 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 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.
Return on Equity = Net Profit ÷ Shareholders Equity
ROE is assessed against cost of equity, which is measured using the Capital Asset Pricing Model (CAPM) – but let’s not dive into the details of that today. For now, let’s just look at the cost of equity number for TNS energo Rostov-on-Don, which is 15.59%. This means TNS energo Rostov-on-Don’s returns actually do not cover its own cost of equity, with a discrepancy of -0.012%. 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 split up into three useful 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. Asset turnover reveals how much revenue can be generated from TNS energo Rostov-on-Don’s 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 TNS energo Rostov-on-Don’s debt-to-equity ratio to examine sustainability of its returns. The ratio currently stands is significantly high, above 2.5 times, meaning TNS energo Rostov-on-Don has taken on a disproportionately large level of debt which is driving the high return. The company’s ability to produce profit growth hinges on its large debt burden.
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. TNS energo Rostov-on-Don’s above-industry ROE is noteworthy, but it was not high enough to cover its own 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. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.
For TNS energo Rostov-on-Don, there are three pertinent factors you should further research:
- 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.
- Future Earnings: How does TNS energo Rostov-on-Don’s growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
- 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!