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. We'll use ROE to examine Astro Malaysia Holdings Berhad (KLSE:ASTRO), by way of a worked example.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
Check out our latest analysis for Astro Malaysia Holdings Berhad
How Do You Calculate Return On Equity?
ROE can be calculated by using the formula:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Astro Malaysia Holdings Berhad is:
6.1% = RM74m ÷ RM1.2b (Based on the trailing twelve months to July 2024).
The 'return' is the income the business earned over the last year. Another way to think of that is that for every MYR1 worth of equity, the company was able to earn MYR0.06 in profit.
Does Astro Malaysia Holdings Berhad Have A Good Return On Equity?
One simple way to determine if a company has a good return on equity is to compare it to the average for its industry. The limitation of this approach is that some companies are quite different from others, even within the same industry classification. The image below shows that Astro Malaysia Holdings Berhad has an ROE that is roughly in line with the Media industry average (6.1%).
That isn't amazing, but it is respectable. Even if the ROE is respectable when compared to the industry, its worth checking if the firm's ROE is being aided by high debt levels. If true, then it is more an indication of risk than the potential.
How Does Debt Impact Return On Equity?
Companies usually need to invest money to grow their profits. That cash can come from issuing shares, retained earnings, or debt. In the first two cases, the ROE will capture this use of capital to grow. In the latter case, the use of debt will improve the returns, but will not change the equity. That will make the ROE look better than if no debt was used.
Astro Malaysia Holdings Berhad's Debt And Its 6.1% ROE
Astro Malaysia Holdings Berhad clearly uses a high amount of debt to boost returns, as it has a debt to equity ratio of 1.49. Its ROE is quite low, even with the use of significant debt; that's not a good result, in our opinion. Debt increases risk and reduces options for the company in the future, so you generally want to see some good returns from using it.