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Inside ROE

The DuPont formula segments ROE and helps us make more sense of it


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ROE (return on equity) is one of the most important and common ratios used to analyse a company. And why not? We all want to see how much of the income is attributable to shareholders, who own the equity. However, just dividing net income by shareholders' equity can only tell you so much. In the 1920s, the DuPont Corporation developed a formula which broke ROE into three components: profit margin, asset turnover and financial leverage. This helps us understand the reason behind the increase or decrease in ROE. Here is the DuPont equation:

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ROE = (Net income/Sales) x (Sales/Total assets) x (Total assets/Total equity)

The first part of the formula calculates profit margin. Profit margins usually increase if there is any increase in the selling price and/or decrease in expenses. An increase in the profit margin reflects a strong bargaining power. Asset turnover (the second part of the formula) tells us how efficiently a company is able to use its assets to generate revenue. A high asset turnover is usually the result of a company successfully increasing its sales and managing its assets in an optimal manner.

These two components examine the operations of a business. It is usually preferable that ROE increases due to any one or both of these factors (in case of the highlighted names, it increases because of both). However, it is worth noting here that net profit margin and asset turnover can be in contrast. For example, a company in the fast-food business may have a high asset turnover due to relatively lower assets but lower profit margins. Similarly, a manufacturer of customised and expensive equipment may have a low asset turnover but high profit margins.

The third part of the equation is financial leverage, which is also known as the equity multiplier. It tells us how much debt a company uses to fund its assets. Let's say a company has Rs 100 as assets and Rs 20 as owners' equity. The balance-sheet equation (assets less liability equals to equity) will signify Rs 80 as company debt. Hence, if a company borrows more to finance its assets, the ratio has to increase. This increases a company's risk of default and makes it riskier. However, the equity multiplier may increase due to reasons apart from an increase in debt.

We applied DuPont equation on the companies which have an ROE of more than 20 per cent. The tables list the results as per each segment.

Profit margins of companies with 20 per cent ROE and market cap greater than Rs 1000 Cr

Company name Profit margin (%)
2018 2017 2016 2015
Eris Lifesciences Ltd 34.48 32.9 22.37 16.29
Indiabulls Real Estate Ltd 33.49 15.28 10.9 10.28
Muthoot Finance Ltd 27.22 20.42 16.62 15.53
Caplin Point Laboratories Ltd 26.79 23.78 19.17 16.33
MAS Financial Services Ltd 23.36 19.06 18.22 17.33
Strides Pharma Science Ltd 20.88 11.65 3.48 0.08
Eicher Motors Ltd 20.86 19.19 17.07 7.5
Bajaj Finance Ltd 19.89 18.43 17.53 16.68
Navin Fluorine International Ltd 19.72 17.49 11.57 9.25
Can Fin Homes Ltd 19.55 17.39 14.51 10.57
Mahanagar Gas Ltd 19.48 17.57 13.6 13.13
IIFL Holdings Ltd 18.51 17.07 14.04 13.41
Tata Chemicals Ltd 18.38 7.97 5.66 4.6
Cholamandalam Investment & Finance Company Ltd 17.7 15.3 13.64 11.96
Dabur India Ltd 17.52 16.62 15.94 13.51
Mayur Uniquoters Ltd 16.67 15.67 14.12 11.82
Castrol India Ltd* 16.57 16.09 15.36 11.63
GIC Housing Finance Ltd 16.37 14.77 14.24 14.09
Pidilite Industries Ltd 15.46 14.15 14.1 9.91
Maithan Alloys Ltd 15.43 12.79 6.52 4.54
Avanti Feeds Ltd 13.72 8.66 7.88 6.55
Elantas Beck India Ltd* 13.63 13.3 10.8 8.26
Orient Refractories Ltd 13.5 12.39 11.29 10.86
TTK Prestige Ltd 13.25 8.04 7.42 6.49
Akzo Nobel India Ltd 13.15 7.88 7.3 6.66
Balaji Amines Ltd 12.91 11.27 8.25 4.93
BLS International Services Ltd 12.23 7.89 6.12 5.24
Bharat Rasayan Ltd 12.13 8.07 6.93 6.67
3M India Ltd 12.03 9.8 8.76 5.62
Solar Industries (India) Ltd 11.97 11.38 11.28 10.69
Garware Technical Fibres Ltd 11.88 9.93 7.47 5.48
Gulf Oil Lubricants India Ltd 11.5 9.33 8.58 6.94
Hero MotoCorp Ltd 11.09 10.42 10.02 8.03
Bodal Chemicals Ltd 10.68 9.93 8.7 8.13
Sterling Tools Ltd 10.5 9.45 6.74 5.61
Asian Paints Ltd 10.27 10.18 9.91 8.63
DCM Shriram Ltd 9.54 9.03 4.98 3.58
Suprajit Engineering Ltd 9.52 8.78 7.76 7.53
Tasty Bite Eatables Ltd 8.93 8.67 7.69 6.06
VIP Industries Ltd 8.74 6.52 5.38 4.38
Bhansali Engineering Polymers Ltd 8.27 5.06 2.72 0.73
Relaxo Footwears Ltd 8.2 7.26 6.94 6.87
VenkyS (India) Ltd 7.43 5.04 1.8 1.08
Dilip Buildcon Ltd 7.18 6.72 5.34 2.94
Lux Industries Ltd 6.96 6.23 5.46 4.98
Rain Industries Ltd* 6.91 3.12 2.89 0.57
Minda Industries Ltd 6.77 4.51 4.09 2.5
Sheela Foam Ltd 6.67 6.63 6.17 2.75
HG Infra Engineering Ltd 6.05 5.06 4.07 2.53
Endurance Technologies Ltd 5.86 5.51 5.35 4.84
Automotive Axles Ltd 5.4 3.8 2.88 2.07
BASF India Ltd 4.31 -0.26 -0.59 -1.31
KEI Industries Ltd 4.13 3.31 2.48 1.59
Jindal Stainless (Hisar) Ltd 4.13 2.79 0.47 -0.07
TVS Motor Company Ltd 3.99 3.75 3.41 2.9
* Financial year ending Dec 2017

Asset turnovers of companies with 20 per cent ROE and market cap greater than Rs 1000 Cr

Company name Asset turnover (times)
2018 2017 2016 2015
Mishtann Foods Ltd 7.36 5.07 3.63 0.2
Hindustan Petroleum Corporation Ltd 2.9 2.89 2.55 2.52
Vakrangee Ltd 2.48 1.84 1.55 1.48
Automotive Axles Ltd 2.4 2.32 2.19 0.91
VenkyS (India) Ltd 1.93 1.73 1.45 1.31
Maithan Alloys Ltd 1.79 1.65 1.53 1.48
Hexaware Technologies Ltd 1.71 1.69 1.67 1.46
West Coast Paper Mills Ltd 1.59 1.14 0.99 0.87
BASF India Ltd 1.48 1.44 1.2 1.07
Ahluwalia Contracts (India) Ltd 1.35 1.21 1.15 1.02
Balaji Amines Ltd 1.19 1.15 1.14 1.08
CRISIL Ltd* 1.17 1.16 1.09 1.06
Meghmani Organics Ltd 1.09 0.97 0.93 0.88
KNR Construction Ltd 0.87 0.8 0.6 0.54
Dilip Buildcon Ltd 0.83 0.74 0.72 0.6
Thyrocare Technologies Ltd 0.79 0.72 0.66 0.56
Oracle Financial Services Software Ltd 0.77 0.77 0.5 0.35
Reliance Nippon Life Asset Management Ltd 0.69 0.66 0.65 0.47
Bharat Dynamics Ltd 0.63 0.55 0.45 0.34
Adani Transmission Ltd 0.25 0.23 0.19 0.02
Muthoot Finance Ltd 0.2 0.2 0.18 0.16
* Financial year ending Dec 2017

Financial leverage of companies with 20 per cent ROE and market cap greater than Rs 1000 Cr

Company name Assets to equity (times)
2018 2017 2016 2015
Coal India Ltd 5.35 3.81 2.92 2.55
Bajaj Consumer Care Ltd 1.21 1.19 1.17 1.14

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