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). By way of learning-by-doing, we'll look at ROE to gain a better understanding of China Aviation Oil (Singapore) Corporation Ltd (SGX:G92).

Our data shows China Aviation Oil (Singapore) has a return on equity of 12% for the last year. Another way to think of that is that for every SGD1 worth of equity in the company, it was able to earn SGD0.12.

See our latest analysis for China Aviation Oil (Singapore)

How Do You Calculate Return On Equity?

The formula for return on equity is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

Or for China Aviation Oil (Singapore):

12% = US$97m ÷ US$808m (Based on the trailing twelve months to September 2019.)

It's easy to understand the 'net profit' part of that equation, but 'shareholders' equity' requires further explanation. It is the capital paid in by shareholders, plus any retained earnings. The easiest way to calculate shareholders' equity is to subtract the company's total liabilities from the total assets.

What Does Return On Equity Mean?

ROE measures a company's profitability against the profit it retains, and any outside investments. The 'return' is the amount earned after tax over the last twelve months. A higher profit will lead to a higher ROE. So, as a general rule, a high ROE is a good thing. That means ROE can be used to compare two businesses.

Does China Aviation Oil (Singapore) Have A Good Return On Equity?

By comparing a company's ROE with its industry average, we can get a quick measure of how good it is. Importantly, this is far from a perfect measure, because companies differ significantly within the same industry classification. As you can see in the graphic below, China Aviation Oil (Singapore) has a higher ROE than the average (8.4%) in the Oil and Gas industry.

That's what I like to see. We think a high ROE, alone, is usually enough to justify further research into a company. For example, I often check if insiders have been buying shares.

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 retained earnings, issuing new shares (equity), or debt. 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.