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While some investors are already well versed in financial metrics (hat tip), this article is for those who would like to learn about Return On Equity (ROE) and why it is important. By way of learning-by-doing, we’ll look at ROE to gain a better understanding AIMS AMP Capital Industrial REIT (SGX:O5RU).
Our data shows AIMS AMP Capital Industrial REIT has a return on equity of 8.1% for the last year. One way to conceptualize this, is that for each SGD1 of shareholders’ equity it has, the company made SGD0.081 in profit.
See our latest analysis for AIMS AMP Capital Industrial REIT
How Do I Calculate ROE?
The formula for ROE is:
Return on Equity = Net Profit ÷ Shareholders’ Equity
Or for AIMS AMP Capital Industrial REIT:
8.1% = 75.915 ÷ S$939m (Based on the trailing twelve months to September 2018.)
It’s easy to understand the ‘net profit’ part of that equation, but ‘shareholders’ equity’ requires further explanation. It is the capital paid in by shareholders, plus any retained earnings. The easiest way to calculate shareholders’ equity is to subtract the company’s total liabilities from the total assets.
What Does ROE Signify?
ROE measures a company’s profitability against the profit it retains, and any outside investments. The ‘return’ is the yearly profit. That means that the higher the ROE, the more profitable the company is. So, all else equal, investors should like a high ROE. That means it can be interesting to compare the ROE of different companies.
Does AIMS AMP Capital Industrial REIT Have A Good Return On Equity?
Arguably the easiest way to assess company’s ROE is to compare it with the average in its industry. However, this method is only useful as a rough check, because companies do differ quite a bit within the same industry classification. If you look at the image below, you can see AIMS AMP Capital Industrial REIT has a similar ROE to the average in the reits industry classification (6.9%).
That’s not overly surprising. ROE can change from year to year, based on decisions that have been made in the past. So it makes sense to check how long the board and CEO have been in place.
How Does Debt Impact Return On Equity?
Virtually all companies need money to invest in the business, to grow profits. That cash can come from retained earnings, issuing new shares (equity), or debt. In the case of the first and second options, the ROE will reflect this use of cash, for growth. In the latter case, the debt used for growth will improve returns, but won’t affect the total equity. In this manner the use of debt will boost ROE, even though the core economics of the business stay the same.