Should we be pleased with Ramky Infrastructure Limited’s (NSE:RAMKY) 38% ROE?

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). To keep the lesson grounded in practicality, we will use ROE to better understand Ramky Infrastructure Limited (NSE: RAMKY).

Return on equity or ROE is an important factor for a shareholder to consider as it tells them how much of their capital is being reinvested. In other words, it is a profitability ratio that measures the rate of return on capital contributed by the company’s shareholders.

Discover our latest analysis for Ramky Infrastructure

How is ROE calculated?

the return on equity formula is:

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

So, based on the above formula, the ROE for Ramky Infrastructure is:

38% = ₹1.7 billion ÷ ₹4.5 billion (based on the last twelve months to December 2021).

The “return” is the annual profit. Another way to think about this is that for every ₹1 worth of equity, the company was able to make a profit of ₹0.38.

Does Ramky Infrastructure 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. However, this method is only useful as a rough check, as companies differ quite a bit within the same industry classification. As you can see in the graph below, Ramky Infrastructure has an above average ROE (8.0%) for the construction industry.

NSEI: RAMKY Return on Equity April 28, 2022

It’s a good sign. That said, a high ROE does not always mean high profitability. Especially when a company uses high levels of debt to finance its debt, which can increase its ROE, but the high leverage puts the company at risk. You can see the 2 risks we have identified for Ramky Infrastructure by visiting our risk dashboard for free on our platform here.

Why You Should Consider Debt When Looking at ROE

Most businesses need money – from somewhere – to increase their profits. This money can come from issuing shares, retained earnings or debt. In the first and second case, the ROE will reflect this use of cash for investment in the business. In the latter case, the debt necessary for growth will boost returns, but will not impact equity. So using debt can improve ROE, but with the added risk of stormy weather, metaphorically speaking.

Combine Ramky Infrastructure’s debt and its 38% return on equity

Of note is the heavy use of debt by Ramky Infrastructure, leading to its debt-to-equity ratio of 1.60. Its ROE is quite impressive, but it probably would have been lower without the use of debt. 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.

Conclusion

Return on equity is useful for comparing the quality of different companies. A company that can earn a high return on equity without going into debt could be considered a high quality company. All things being equal, a higher ROE is better.

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. You can see how the company has grown in the past by watching this FREE detailed graph past profits, revenue and cash flow.

But note: Ramky Infrastructure 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.

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