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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. To keep the lesson grounded in practicality, we'll use ROE to better understand Kalyani Steels Limited (NSE:KSL).

Our data shows Kalyani Steels has a return on equity of 15% for the last year. That means that for every ₹1 worth of shareholders' equity, it generated ₹0.15 in profit.

View our latest analysis for Kalyani Steels

How Do You Calculate ROE?

The formula for ROE is:

Return on Equity = Net Profit ÷ Shareholders' Equity

Or for Kalyani Steels:

15% = ₹1.3b ÷ ₹8.8b (Based on the trailing twelve months to March 2019.)

Most readers would understand what net profit is, but it’s worth explaining the concept of shareholders’ equity. It is all the money paid into the company from shareholders, plus any earnings retained. Shareholders' equity can be calculated by subtracting the total liabilities of the company from the total assets of the company.

What Does Return On Equity Mean?

Return on Equity measures a company's profitability against the profit it has kept for the business (plus any capital injections). The 'return' is the amount earned after tax over the last twelve months. 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 Kalyani Steels Have A Good ROE?

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 you can see in the graphic below, Kalyani Steels has a higher ROE than the average (11%) in the Metals and Mining industry.

That's what I like to see. In my book, a high ROE almost always warrants a closer look. For example, I often check if insiders have been buying shares .

The Importance Of Debt To Return On Equity

Virtually all companies need money to invest in the business, to grow profits. The cash for investment can come from prior year profits (retained earnings), issuing new shares, or borrowing. In the first and second cases, the ROE will reflect this use of cash for investment in the business. In the latter case, the debt required for growth will boost returns, but will not impact the shareholders' equity. In this manner the use of debt will boost ROE, even though the core economics of the business stay the same.