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One of the best investments we can make is in our own knowledge and skill set. With that in mind, this article will work through how we can use Return On Equity (ROE) to better understand a business. By way of learning-by-doing, we'll look at ROE to gain a better understanding of Coca-Cola Europacific Partners PLC (AMS:CCEP).
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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.
See our latest analysis for Coca-Cola Europacific Partners
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 Coca-Cola Europacific Partners is:
18% = €1.6b ÷ €9.0b (Based on the trailing twelve months to June 2024).
The 'return' is the profit over the last twelve months. That means that for every €1 worth of shareholders' equity, the company generated €0.18 in profit.
Does Coca-Cola Europacific Partners Have A Good ROE?
One simple way to determine if a company has a good return on equity is to compare it to the average for its industry. Importantly, this is far from a perfect measure, because companies differ significantly within the same industry classification. Pleasingly, Coca-Cola Europacific Partners has a superior ROE than the average (10.0%) in the Beverage industry.
That's clearly a positive. Bear in mind, a high ROE doesn't always mean superior financial performance. Aside from changes in net income, a high ROE can also be the outcome of high debt relative to equity, which indicates risk. Our risks dashboardshould have the 2 risks we have identified for Coca-Cola Europacific Partners.
The Importance Of Debt To Return On Equity
Companies usually need to invest money to grow their 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 Coca-Cola Europacific Partners' Debt And Its 18% Return On Equity
Coca-Cola Europacific Partners clearly uses a high amount of debt to boost returns, as it has a debt to equity ratio of 1.29. While its ROE is pretty respectable, the amount of debt the company is carrying currently is not ideal. Investors should think carefully about how a company might perform if it was unable to borrow so easily, because credit markets do change over time.