Is Adani Green Energy Limited (NSE:ADANIGREEN) a high-quality stock to own? | Rare Techy

Although some investors are already well versed in financial metrics (hat tip), this article is for those who want to learn about Return On Equity (ROE) and why it matters. We will use ROE to examine Adani Green Energy Limited (NSE:ADANIGREEN), by way of a working example.

Return on equity or ROE is an important factor for shareholders to consider because it tells how effectively their capital is being reinvested. In other words, it is a profitability ratio that measures the rate of return on capital provided by the company’s shareholders.

Our analysis shows that ADANIGREEN is potentially overvalued!

How is ROE Calculated?

Return on equity can be calculated using the formula:

Return on Equity = Net Profit (from continuing operations) ÷ Stockholders’ Equity

So, based on the above formula, the ROE for Adani Green Energy is:

19% = ₹4.8b ÷ ₹26b (Based on trailing twelve months to June 2022).

‘Back’ is the amount earned after tax over the last twelve months. Another way to think of it is that for every ₹1 of equity, the company can make a profit of ₹0.19.

Does Adani Green Energy have a good ROE?

Perhaps the easiest way to assess a company’s ROE is to compare it to the average in its industry. A limitation of this approach is that some companies are quite different from others, even within the same industry classification. As you can see in the graph below, Adani Green Energy has a higher ROE than the average (11%) in the Renewable Energy industry.

It is clearly positive. However, keep in mind that a high ROE does not necessarily indicate efficient profit generation. Aside from changes in net income, a high ROE can also be the result of high debt relative to equity, which indicates risk.

Why You Should Consider Debt When Looking at ROE

Companies usually have to invest money to grow their profits. Cash for investment can come from prior year profits (retained earnings), issuing new shares, or borrowing. In the first and second cases, ROE will reflect the use of this cash for investment in the business. In the latter case, the debt required for growth will increase revenue, but will not affect shareholder equity. In this way, the use of debt will increase ROE, even if the core economy of the business remains the same.

Adani Green Energy’s debt and its 19% ROE

It seems that Adani Green Energy uses a large volume of debt to finance the business, since it has a very high debt to equity ratio of 20.21. The ROE is decent, but once I factor in all the debt, I’m not that impressed.

conclusion

Return on equity is one way we can compare the quality of business of different companies. A company that can achieve a high return on equity without debt can be considered a high-quality business. If two companies have the same level of debt and equity, and one has a higher ROE, I generally prefer the one with the higher ROE.

But ROE is only one piece of a larger puzzle, as high-quality businesses often trade at high multiples of earnings. It is important to consider other factors, such as future profit growth — and how much investment is needed in the future. So you might want to check out this FREE visualization of analyst forecasts for companies.

Of course, You can find a good investment by looking elsewhere. So take a look at this free list of interesting companies.

Have feedback on this article? Concerned about content? Get in touch and we are direct. Alternatively, email the editorial-team (at) simplywallst.com.

This article is by Simply Wall St in general. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended as financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take into account your goals, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in recent price-sensitive company announcements or qualitative material. Simply Wall St has no position in the mentioned stocks.