Many investors are still learning the different metrics that can be useful when analyzing a stock. This article is for those who want to know more about return on equity (ROE). Learning by doing, we will look at ROE to better understand Mangalore Chemicals & Fertilizers Limited (NSE: MANGCHEFER).

Return on Equity or ROE is a test of how effectively a company increases its value and manages investors’ money. In simple terms, it is used to assess the profitability of a company in relation to its equity.

Check out our latest analysis for Mangalore Chemicals & Fertilizers

How do you calculate return on equity?

the return on equity formula is:

Return on equity = Net income (from continuing operations) ÷ Equity

So, based on the above formula, the ROE for Mangalore Chemicals & Fertilizers is:

15% = ₹991m ÷ ₹6.6b (Based on last twelve months to December 2021).

“Yield” is the income the business has earned over the past year. This means that for every ₹ of equity, the company generated ₹0.15 of profit.

Does Mangalore Chemicals & Fertilizers have a good ROE?

A simple way to determine if a company has a good return on equity is to compare it to the average for its industry. The limitation of this approach is that some companies are quite different from others, even within the same industrial classification. The image below shows that Mangalore Chemicals & Fertilizers has an ROE that is roughly in line with the chemical industry average (15%).

NSEI: MANGCHEFER Return on Equity February 4, 2022

It’s not surprising, but it’s respectable. Although at least the ROE is not lower than the industry, it is always worth checking the role that the company’s debt plays, since high levels of debt relative to equity can also give the impression that the ROE is high. If a company takes on too much debt, it runs a higher risk of defaulting on interest payments. You can see the 2 risks we have identified for Mangalore Chemicals & Fertilizers by visiting our risk dashboard for free on our platform here.

What is the impact of debt on ROE?

Virtually all businesses need money to invest in the business, to increase their profits. The money for the investment can come from the previous year’s earnings (retained earnings), from issuing new shares or from borrowing. In the first and second case, the ROE will reflect this use of cash for investment in the business. In the latter case, debt used for growth will enhance returns, but will not affect total equity. In this way, the use of debt will increase ROE, even though the core economics of the business remains the same.

Mangalore Chemicals & Fertilizers’ debt and its 15% ROE

Mangalore Chemicals & Fertilizers uses a high amount of debt to increase returns. Its debt to equity ratio is 1.33. With a fairly low ROE and a significant reliance on debt, it is difficult to get enthusiastic about this activity at the moment. Investors need to think carefully about how a company would perform if it weren’t able to borrow so easily, as credit markets change over time.

Summary

Return on equity is a way to compare the business quality of different companies. In our books, the highest quality companies have a high return on equity, despite low leverage. If two companies have roughly the same level of debt and one has a higher ROE, I generally prefer the one with a higher ROE.

But ROE is only one piece of a larger puzzle, as high-quality companies often trade on high earnings multiples. It is important to consider other factors, such as future earnings growth and the amount of investment needed in the future. So I think it’s worth checking it out free this detailed graph past profits, revenue and cash flow.

But note: Mangalore Chemicals & Fertilizers may not be the best stock to buy. So take a look at this free list of interesting companies with high ROE and low debt.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.