With An ROE Of 18.71%, Has Johnson Controls – Hitachi Air Conditioning India Limited’s (NSE:JCHAC) Management Done Well?
This analysis is intended to introduce important early concepts to people who are starting to invest and want a simplistic look at the return on Johnson Controls – Hitachi Air Conditioning India Limited (NSE:JCHAC) stock.
Johnson Controls – Hitachi Air Conditioning India Limited (NSE:JCHAC) outperformed the Household Appliances industry on the basis of its ROE – producing a higher 18.71% relative to the peer average of 12.25% over the past 12 months. On the surface, this looks fantastic since we know that JCHAC has made large profits from little equity capital; however, ROE doesn’t tell us if management have borrowed heavily to make this happen. We’ll take a closer look today at factors like financial leverage to determine whether JCHAC’s ROE is actually sustainable. Check out our latest analysis for Johnson Controls – Hitachi Air Conditioning India
Peeling the layers of ROE – trisecting a company’s profitability
Return on Equity (ROE) is a measure of Johnson Controls – Hitachi Air Conditioning India’s profit relative to its shareholders’ equity. For example, if the company invests ₹1 in the form of equity, it will generate ₹0.19 in earnings from this. While a higher ROE is preferred in most cases, there are several other factors we should consider before drawing any conclusions.
Return on Equity = Net Profit ÷ Shareholders Equity
ROE is measured against cost of equity in order to determine the efficiency of Johnson Controls – Hitachi Air Conditioning India’s equity capital deployed. Its cost of equity is 13.55%. This means Johnson Controls – Hitachi Air Conditioning India returns enough to cover its own cost of equity, with a buffer of 5.17%. This sustainable practice implies that the company pays less 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
The first component is profit margin, which measures how much of sales is retained after the company pays for all its expenses. Asset turnover reveals how much revenue can be generated from Johnson Controls – Hitachi Air Conditioning India’s asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. Since ROE can be artificially increased through excessive borrowing, we should check Johnson Controls – Hitachi Air Conditioning India’s historic debt-to-equity ratio. At 2.37%, Johnson Controls – Hitachi Air Conditioning India’s debt-to-equity ratio appears low and indicates the above-average ROE is generated from its capacity to increase profit without a large debt burden.
Next Steps:
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. Johnson Controls – Hitachi Air Conditioning India’s above-industry ROE is encouraging, and is also in excess of its cost of equity. ROE is not likely to be inflated by excessive debt funding, giving shareholders more conviction in the sustainability of high returns. Although ROE can be a useful metric, it is only a small part of diligent research.
For Johnson Controls – Hitachi Air Conditioning India, there are three important aspects 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 Johnson Controls – Hitachi Air Conditioning India 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 Johnson Controls – Hitachi Air Conditioning India is currently mispriced by the market.
Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Johnson Controls – Hitachi Air Conditioning India? 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.
