It is calculated by dividing the companys net income before common stock dividends are paid by the companys net worth, which is the stockholders equity.
If the RoNW is higher than the companys return on assets, it may be a sign that the management is using leverage to increase profits and profit margins.
In general, its considered a sign of good management when a companys performance over time is at least as good as the average return on net worth for other companies in the same industry.
A comparative study has been made for 37 profit-making public sector units excluding banks and NBFCs (central and state) from 2009-10 to 2010-11.These companies aggregated a net profit of R75,921 crore in 2010-11 as against R70,071 crore in 2009-10.
The total net worth of these companies increased by 13.3% to R4.62 lakh crore (R4.08 lakh crore) during 2010-11. The study on these 37 PSUs reveals that the ratio of net profit to total net worth, which is used to measure the return on equity, decreased from 17.16% in 2009-10 to 16.41% in 2010-11, indicating lower return on equity during 2010-11. The low RoNW of PSUs in FY11 could be attributed to the rise in net worth.
An analyst from a rating agency said, The return on net worth of PSUs has decreased mainly because of lower level of profits, besides increase in net worth during the year under report. The major reason for the same seems to be less efficient operations, lower demand/supply situation and lower realisations thereby PSUs getting less benefits of economy of scale.
The top five PSUs according to net profit to net worth ratio during 2010-11 are Madras Fertilisers, Andrew Yule & Co, Engineers India, NMDC and BHEL. The fifth rank of BHEL in 2010-11 can be explained from its performance. The net profit of the company increased by 39.5% to R6,011 crore, against R4,310 crore during 2009-10. The net worth of the company also increased by 26.6% to R20,154 crore during 2010-11.
A significant increase in return on net worth was witnessed in the case of GSFC, Madras Fertilisers, NMDC, Petronet LNG, Hindustan Copper and GNFC.
Petronet LNG posted a net profit of R620 crore, against R404 crore in 2009-10, registering an increase of 53.2%. And its net worth increased by 19.9% during the study period.
On the other hand a significant fall in RoNW was observed in the case of Andrew Yule, Engineers India, Tide Water Oil, Balmar Lawrie, Chennai Petroleum Corporation Ltd (CPCL), Indian Oil, Gujarat Alkalies and BEML. The net profit of Engineers India increased from R435 crore during 2009-10 to R522 crore during 2010-11. But its net worth increased by 29.4% during the same period.
In the sector-wise analysis, significant decline in return on equity was seen in the case of refineries, diversified, steel and telecommunications. The RoNW of refineries industry decreased from 17.37% during 2009-10 to 12.89% during 2010-11.