What You Must Know About Public Joint Stock Company Gazprom’s (MCX:GAZP) 7.42% ROE
Public Joint Stock Company Gazprom (MISX:GAZP) delivered a less impressive 7.42% ROE over the past year, compared to the 13.40% return generated by its industry. Though GAZP’s recent performance is underwhelming, it is useful to understand what ROE is made up of and how it should be interpreted. Knowing these components can change your views on GAZP’s below-average returns. I will take you through how metrics such as financial leverage impact ROE which may affect the overall sustainability of GAZP’s returns. See our latest analysis for Gazprom
What you must know about ROE
Return on Equity (ROE) weighs Gazprom’s profit against the level of its shareholders’ equity. An ROE of 7.42% implies RUB0.07 returned on every RUB1 invested, so the higher the return, the better. If investors diversify their portfolio by industry, they may want to maximise their return in the Integrated Oil and Gas sector by investing in the highest returning stock. But this can be misleading as each company has different costs of equity and also varying debt levels, which could artificially push up ROE whilst accumulating high interest expense.
Return on Equity = Net Profit ÷ Shareholders Equity
ROE is measured against cost of equity in order to determine the efficiency of Gazprom’s equity capital deployed. Its cost of equity is 13.69%. This means Gazprom’s returns actually do not cover its own cost of equity, with a discrepancy of -6.27%. This isn’t sustainable as it implies, very simply, that the company pays more for its capital than what it generates in return. ROE can be dissected into three distinct ratios: net profit margin, asset turnover, and financial leverage. This is called the 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 Gazprom’s asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. We can assess whether Gazprom is fuelling ROE by excessively raising debt. Ideally, Gazprom should have a balanced capital structure, which we can check by looking at the historic debt-to-equity ratio of the company. The ratio currently stands at a sensible 26.61%, meaning Gazprom has not taken on excessive debt to drive its returns. The company is able to produce profit growth without a huge debt burden and still has headroom to grow returns to industry average.
ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. Gazprom exhibits a weak ROE against its peers, as well as insufficient levels to cover its own cost of equity this year. Although, its appropriate level of leverage means investors can be more confident in the sustainability of Gazprom’s return with a possible increase should the company decide to increase its debt levels. Although ROE can be a useful metric, it is only a small part of diligent research.
For Gazprom, I’ve put together three pertinent aspects you should further research:
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