Why Rail Vikas Nigam Limited (NSE:RVNL) looks like a quality company

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. We will use ROE to look at Rail Vikas Nigam Limited (NSE:RVNL), as a concrete example.

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.

See our latest analysis for Rail Vikas Nigam

How do you calculate return on equity?

ROE can be calculated using the formula:

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

So, based on the above formula, the ROE for Rail Vikas Nigam is:

18% = ₹11 billion ÷ ₹61 billion (based on the last twelve months to September 2021).

“Yield” is the income the business has earned over the past year. One way to conceptualize this is that for every ₹1 of share capital it has, the company has made a profit of ₹0.18.

Does Rail Vikas Nigam have a good ROE?

Perhaps the easiest way to assess a company’s ROE is to compare it to the industry average. It is important to note that this measure is far from perfect, as companies differ significantly within the same industry classification. As you can see in the graph below, Rail Vikas Nigam has an above average ROE (7.7%) for the construction industry.

NSEI:RVNL Return on Equity January 18, 2022

This is clearly a positive point. Keep in mind that a high ROE does not always mean superior financial performance. 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. To know the 2 risks we have identified for Rail Vikas Nigam visit our risk dashboard for free.

What is the impact of debt on return on equity?

Most businesses need money – from somewhere – to increase their profits. This money can come from retained earnings, issuing new stock (shares), 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, debt used for growth will enhance returns, but will not affect total equity. In this way, the use of debt will increase ROE, even though the core economics of the business remains the same.

Combine Rail Vikas Nigam’s debt and 18% return on equity

Rail Vikas Nigam is clearly using a high amount of debt to boost its returns as its debt to equity ratio is 1.01. Although its ROE is quite respectable, the amount of debt the company is currently carrying is not ideal. Debt increases risk and reduces options for the business in the future, so you generally want to see good returns using it.

Conclusion

Return on equity is a way to compare the business quality of different companies. In our books, the highest quality companies have a high return on equity, despite low leverage. All things being equal, a higher ROE is better.

But when a company is of high quality, the market often gives it a price that reflects that. It is important to consider other factors, such as future earnings growth and the amount of investment needed in the future. So I think it’s worth checking it out free analyst forecast report for the company.

Sure Rail Vikas Nigam 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.

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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