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Many investors are still learning about the various metrics that can be useful when analysing a stock. This article is for those who would like to learn about Return On Equity (ROE). We'll use ROE to examine B&S Group S.A. (AMS:BSGR), 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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
Check out our latest analysis for B&S Group
How Is ROE Calculated?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for B&S Group is:
18% = €48m ÷ €260m (Based on the trailing twelve months to December 2023).
The 'return' is the yearly profit. That means that for every €1 worth of shareholders' equity, the company generated €0.18 in profit.
Does B&S Group 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. The limitation of this approach is that some companies are quite different from others, even within the same industry classification. You can see in the graphic below that B&S Group has an ROE that is fairly close to the average for the Retail Distributors industry (17%).
That's neither particularly good, nor bad. While at least the ROE is not lower than the industry, its still worth checking what role the company's debt plays as high debt levels relative to equity may also make the ROE appear high. If true, then it is more an indication of risk than the potential. You can see the 2 risks we have identified for B&S Group by visiting our risks dashboard for free on our platform here.
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 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 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.
Combining B&S Group's Debt And Its 18% Return On Equity
It's worth noting the high use of debt by B&S Group, leading to its debt to equity ratio of 1.00. There's no doubt its ROE is decent, but the very high debt the company carries is not too exciting to see. Debt does bring extra risk, so it's only really worthwhile when a company generates some decent returns from it.