How Did PJSC LUKOIL’s (MCX:LKOH) 12.05% ROE Fare Against The Industry?
PJSC LUKOIL (MISX:LKOH) delivered a less impressive 12.05% ROE over the past year, compared to the 13.81% return generated by its industry. An investor may attribute an inferior ROE to a relatively inefficient performance, and whilst this can often be the case, knowing the nuts and bolts of the ROE calculation may change that perspective and give you a deeper insight into LKOH’s past performance. Today I will look at how components such as financial leverage can influence ROE which may impact the sustainability of LKOH’s returns. View our latest analysis for PJSC LUKOIL
Breaking down ROE — the mother of all ratios
Return on Equity (ROE) is a measure of PJSC LUKOIL’s profit relative to its shareholders’ equity. An ROE of 12.05% implies RUB0.12 returned on every RUB1 invested. In most cases, a higher ROE is preferred; however, there are many other factors we must consider prior to making any investment decisions.
Return on Equity = Net Profit ÷ Shareholders Equity
ROE is measured against cost of equity in order to determine the efficiency of PJSC LUKOIL’s equity capital deployed. Its cost of equity is 13.41%. Since PJSC LUKOIL’s return does not cover its cost, with a difference of -1.36%, this means its current use of equity is not efficient and not sustainable. Very simply, PJSC LUKOIL pays more for its capital than what it generates in return. ROE can be broken down into three different ratios: net profit margin, asset turnover, and financial leverage. This is called the Dupont Formula:
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
Essentially, profit margin shows how much money the company makes after paying for all its expenses. Asset turnover reveals how much revenue can be generated from PJSC LUKOIL’s asset base. And finally, financial leverage is simply how much of assets are funded by equity, which exhibits how sustainable the company’s capital structure is. Since financial leverage can artificially inflate ROE, we need to look at how much debt PJSC LUKOIL currently has. At 17.66%, PJSC LUKOIL’s debt-to-equity ratio appears low and indicates that PJSC LUKOIL still has room to increase leverage and grow its profits.
Next Steps:
While ROE is a relatively simple calculation, it can be broken down into different ratios, each telling a different story about the strengths and weaknesses of a company. PJSC LUKOIL’s below-industry ROE is disappointing, furthermore, its returns were not even high enough to cover its own cost of equity. Although, its appropriate level of leverage means investors can be more confident in the sustainability of PJSC LUKOIL’s return with a possible increase should the company decide to increase its debt levels. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.
For PJSC LUKOIL, I’ve put together three essential factors you should further research:
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.
Valuation: What is PJSC LUKOIL worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether PJSC LUKOIL is currently mispriced by the market.
Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of PJSC LUKOIL? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!
To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned.
