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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 of IBC Advanced Alloys Corp. (CVE:IB).
Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
View our latest analysis for IBC Advanced Alloys
How Do You Calculate Return On Equity?
The formula for return on equity is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for IBC Advanced Alloys is:
0.8% = US$33k ÷ US$4.1m (Based on the trailing twelve months to September 2024).
The 'return' is the amount earned after tax over the last twelve months. That means that for every CA$1 worth of shareholders' equity, the company generated CA$0.01 in profit.
Does IBC Advanced Alloys 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. As shown in the graphic below, IBC Advanced Alloys has a lower ROE than the average (9.3%) in the Metals and Mining industry classification.
That's not what we like to see. That being said, a low ROE is not always a bad thing, especially if the company has low leverage as this still leaves room for improvement if the company were to take on more debt. A high debt company having a low ROE is a different story altogether and a risky investment in our books. You can see the 4 risks we have identified for IBC Advanced Alloys by visiting our risks dashboard for free on our platform here.
How Does Debt Impact Return On Equity?
Companies usually need to invest money to grow their profits. That cash can come from retained earnings, issuing new shares (equity), or debt. In the first two cases, the ROE will capture this use of capital to grow. In the latter case, the debt required for growth will boost returns, but will not impact the shareholders' equity. That will make the ROE look better than if no debt was used.
Combining IBC Advanced Alloys' Debt And Its 0.8% Return On Equity
We think IBC Advanced Alloys uses a significant amount of debt to maximize its returns, as it has a significantly higher debt to equity ratio of 3.16. We consider it to be a negative sign when a company has a rather low ROE despite a rather high debt to equity.