Is TT Limited’s (NSE:TTL) ROE of 14% strong relative to its industry?
While some investors are already familiar with financial metrics (hat trick), this article is for those who want to learn more about return on equity (ROE) and why it matters. To keep the lesson grounded in practicality, we will use ROE to better understand TT Limited (NSE: TTL).
ROE or return on equity is a useful tool for evaluating how effectively a company can generate returns on the investment it has received from its shareholders. In other words, it is a profitability ratio that measures the rate of return on capital contributed by the company’s shareholders.
How to calculate return on equity?
The ROE formula is:
Return on equity = Net income (from continuing operations) ÷ Equity
So, based on the above formula, the ROE for TT is:
14% = ₹110m ÷ ₹797m (Based on last twelve months to June 2022).
The “yield” is the profit of the last twelve months. This therefore means that for every ₹1 of its shareholder’s investment, the company generates a profit of ₹0.14.
Does TT have a good ROE?
Perhaps the easiest way to assess a company’s ROE is to compare it to the industry average. The limitation of this approach is that some companies are very different from others, even within the same industrial classification. The image below shows that TT has an ROE that roughly matches the Luxury industry average (12%).
It’s neither particularly good nor bad. 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 so, this increases its exposure to financial risk. To learn about the 3 risks we have identified for TT visit our risk dashboard for free.
Why You Should Consider Debt When Looking at ROE
Most businesses need money – from somewhere – 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 case of the first and second options, the ROE will reflect this use of cash, for growth. In the latter case, the debt necessary for growth will boost returns, but will not impact equity. In this way, the use of debt will increase ROE, even though the core economics of the business remains the same.
Combine TT’s debt and its 14% return on equity
TT uses a high amount of debt to increase returns. Its debt to equity ratio is 2.15. Its ROE is quite low, even with the use of significant debt; this is not a good result, in our view. Debt brings additional risk, so it’s only really worth it when a business is generating decent returns.
Return on equity is a useful indicator of a company’s ability to generate profits and return them to shareholders. Companies that can earn high returns on equity without too much debt are generally of good quality. If two companies have the same ROE, I would generally prefer the one with less debt.
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. Check past earnings growth by TT by watching this visualization of past profits, revenue and cash flow.
Sure TT may not be the best stock to buy. So you might want to see this free collection of other companies that have high ROE and low debt.
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Find out if TT is potentially overvalued or undervalued by viewing our full analysis, which includes fair value estimates, risks and warnings, dividends, insider trading and financial health.
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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.