While some investors are already familiar with financial metrics (hat tip), this article is for those who want to learn more about return on equity (ROE) and why it is important. To keep the lesson practical, we will use ROE to better understand Tara Chand Logistic Solutions Limited (NSE: TARACHAND).

Return on equity or ROE is a test of how effectively a company increases its value and manages investor money. Simply put, it is used to assess a company’s profitability against its equity.

See our latest review for Tara Chand Logistic Solutions

How is the ROE calculated?

The return on equity formula is:

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

Thus, based on the above formula, the ROE of Tara Chand Logistic Solutions is:

9.8% = ₹ 54m ₹ 550m (Based on the last twelve months up to June 2021).

The “return” is the annual profit. So this means that for every 1 of its shareholder’s investments, the company generates a profit of ₹ 0.10.

Do Tara Chand’s logistics solutions have a good return on equity?

A simple way to determine if a company has a good return on equity is to compare it to the average in its industry. The limitation of this approach is that some companies are very different from others, even within the same industry classification. As you can see in the graph below, Tara Chand Logistic Solutions has an above-average ROE (7.9%) for the transportation industry.

NSEI: TARACHAND Return on equity October 7, 2021

This is clearly positive. Keep in mind that a high ROE doesn’t always mean superior financial performance. Especially when a business uses high levels of leverage to finance its debt, which can increase its ROE, but high leverage puts the business at risk. You can see the 3 risks that we have identified for Tara Chand Logistic Solutions by visiting our risk dashboard for free on our platform here.

The importance of debt to return on equity

Businesses generally need to invest money to increase their profits. The money for the investment can come from the profits of the previous year (retained earnings), from the issuance of new shares or from loans. In the first two cases, the ROE will capture this use of capital to grow. In the latter case, the debt necessary for growth will increase returns, but will have no impact on equity. So, using debt can improve ROE, but with added risk in stormy weather, metaphorically speaking.

Tara Chand Logistic Solutions’ debt and its ROE of 9.8%

Tara Chand Logistic Solutions uses a high amount of debt to increase returns. Its debt to equity ratio is 1.92. The combination of a rather low ROE and a high recourse to debt is not particularly attractive. Debt comes with additional risk, so it’s only really worth it when a business is making decent returns from it.

Summary

Return on equity is a way to compare the quality of the business of different companies. Firms that can earn high returns on equity without taking on too much debt are generally of good quality. All other things being equal, a higher ROE is preferable.

That said, while ROE is a useful indicator of how good a business is, you’ll need to look at a whole range of factors to determine the right price to buy a stock. It is important to take into account other factors, such as future profit growth and the amount of investment required for the future. You can see how the business has grown in the past by checking out this FREE detailed graphic past profits, income and cash flow.

Sure Tara Chand Logistic Solutions may not be the best stock to buy. So you might want to see this free collection of other companies with high ROE and low leverage.

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

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