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). Learning by doing, we will look at ROE to better understand Power Grid Corporation of India Limited (NSE:POWERGRID).

Return on equity or ROE is a key metric used to gauge how effectively a company’s management is using the company’s capital. In simple terms, it is used to assess the profitability of a company in relation to its equity.

Check out our latest analysis for Power Grid Corporation of India

How do you calculate return on equity?

the return on equity formula is:

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

So, based on the above formula, the ROE of Power Grid Corporation of India is:

21% = ₹162 billion ÷ ₹776 billion (based on the last twelve months to December 2021).

“Yield” refers to a company’s earnings over the past year. Thus, this means that for every ₹1 of its shareholder’s investment, the company generates a profit of ₹0.21.

Does Power Grid Corporation of India have a good ROE?

By comparing a company’s ROE with the average for its industry, we can get a quick measure of its quality. The limitation of this approach is that some companies are very different from others, even within the same industrial classification. As you can see in the chart below, Power Grid Corporation of India has an above average ROE (12%) for the power utility industry.

NSEI:POWERGRID Return on Equity April 21, 2022

That’s what we like to see. 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. Our risk dashboard should include the 3 risks we have identified for Power Grid Corporation of India.

What is the impact of debt on return on equity?

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. So using debt can improve ROE, but with the added risk of stormy weather, metaphorically speaking.

Power Grid Corporation of India’s debt and its ROE of 21%

Power Grid Corporation of India is clearly using a high amount of debt to boost returns as its debt to equity ratio is 1.79. While its ROE is respectable, it’s worth bearing in mind that there’s usually a limit to the amount of debt a company can use. 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.

Summary

Return on equity is a way to compare the business 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. If two companies have the same ROE, I would generally prefer the one with less debt.

That said, while ROE is a useful indicator of a company’s quality, you’ll need to consider a whole host of factors to determine the right price to buy a stock. Earnings growth rates, relative to expectations reflected in the share price, are particularly important to consider. You might want to take a look at this data-rich interactive chart of the company’s forecast.

Sure, you might find a fantastic investment by looking elsewhere. So take a look at this free list of interesting companies.

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.