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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). To keep the lesson grounded in practicality, we'll use ROE to better understand ABO Energy GmbH & Co. KGaA (ETR:AB9).
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 ABO Energy GmbH KGaA
How Do You Calculate Return On Equity?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for ABO Energy GmbH KGaA is:
15% = €30m ÷ €199m (Based on the trailing twelve months to June 2024).
The 'return' is the yearly profit. One way to conceptualize this is that for each €1 of shareholders' capital it has, the company made €0.15 in profit.
Does ABO Energy GmbH KGaA Have A Good ROE?
By comparing a company's ROE with its industry average, we can get a quick measure of how good it is. However, this method is only useful as a rough check, because companies do differ quite a bit within the same industry classification. As you can see in the graphic below, ABO Energy GmbH KGaA has a higher ROE than the average (8.8%) in the Renewable Energy industry.
That's clearly a positive. With that said, a high ROE doesn't always indicate high profitability. Especially when a firm uses high levels of debt to finance its debt which may boost its ROE but the high leverage puts the company at risk. You can see the 2 risks we have identified for ABO Energy GmbH KGaA 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. Thus the use of debt can improve ROE, albeit along with extra risk in the case of stormy weather, metaphorically speaking.
Combining ABO Energy GmbH KGaA's Debt And Its 15% Return On Equity
ABO Energy GmbH KGaA does use a high amount of debt to increase returns. It has a debt to equity ratio of 1.51. While its ROE is pretty respectable, the amount of debt the company is carrying currently is not ideal. Debt does bring extra risk, so it's only really worthwhile when a company generates some decent returns from it.