I am writing today to help inform people who are new to the stock market
and looking to gauge the potential return on investment in Innovative Tech Pack Limited (BOM:523840).
Innovative Tech Pack Limited’s (BOM:523840) most recent return on equity was a substandard 4.86% relative to its industry performance of 8.46% over the past year.
523840’s results could indicate a relatively inefficient operation to its peers, and while this may be the case, it is important to understand what ROE is made up of and how it should be interpreted. Knowing these components could change your view on 523840’s performance.
Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of 523840’s returns. Let me show you what I mean by this.
View out our latest analysis for Innovative Tech Pack
Breaking down Return on Equity
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 ₹1 in the form of equity, it will generate ₹0.049 in earnings from this.
If investors diversify their portfolio by industry, they may want to maximise their return in the Metal and Glass Containers sector by investing in the highest returning stock.
But this can be misleading as each company has different costs of equity and also varying debt levels, which could artificially push up ROE whilst accumulating high interest expense.
Return on Equity = Net Profit ÷ Shareholders Equity
ROE is measured against cost of equity in order to determine the efficiency of Innovative Tech Pack’s equity capital deployed. Its cost of equity is 13.55%.
Since Innovative Tech Pack’s return does not cover its cost, with a difference of -8.69%, this means its current use of equity is not efficient and not sustainable. Very simply, Innovative Tech Pack pays more for its capital than what it generates in return.
ROE can be dissected into three distinct 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
The first component is profit margin, which measures how much of sales is retained after the company pays for all its expenses.
Asset turnover shows how much revenue Innovative Tech Pack can generate with its current asset base.
The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage.
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 Innovative Tech Pack’s debt-to-equity ratio to examine sustainability of its returns.
Currently the ratio stands at 91.27%, which is relatively balanced. This means Innovative Tech Pack has not taken on excessive leverage, and its current ROE is driven by its ability to grow its profit without a significant debt burden.
ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock.
Innovative Tech Pack’s ROE is underwhelming relative to the industry average, and its returns were also not strong enough to cover its own cost of equity.
Although, its appropriate level of leverage means investors can be more confident in the sustainability of Innovative Tech Pack’s return with a possible increase should the company decide to increase its debt levels.
Although ROE can be a useful metric, it is only a small part of diligent research.
For Innovative Tech Pack,
- 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 Innovative Tech Pack’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 Innovative Tech Pack? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!
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