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 Affle (India) Limited (NSE:AFFLE).

Our data shows Affle (India) has a return on equity of 67% for the last year. Another way to think of that is that for every ₹1 worth of equity in the company, it was able to earn ₹0.67.

View our latest analysis for Affle (India)

How Do I Calculate Return On Equity?

The formula for return on equity is:

Return on Equity = Net Profit ÷ Shareholders' Equity

Or for Affle (India):

67% = ₹488m ÷ ₹724m (Based on the trailing twelve months to March 2019.)

Most know that net profit is the total earnings after all expenses, but the concept of shareholders' equity is a little more complicated. It is all earnings retained by the company, plus any capital paid in by shareholders. The easiest way to calculate shareholders' equity is to subtract the company's total liabilities from the total assets.

What Does ROE Signify?

ROE looks at the amount a company earns relative to the money it has kept within the business. The 'return' is the profit over the last twelve months. The higher the ROE, the more profit the company is making. So, all else being equal, a high ROE is better than a low one. That means it can be interesting to compare the ROE of different companies.

Does Affle (India) 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 is clear from the image below, Affle (India) has a better ROE than the average (13%) in the Media 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 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 use of debt will improve the returns, but will not change the equity. In this manner the use of debt will boost ROE, even though the core economics of the business stay the same.

Affle (India)'s Debt And Its 67% ROE

Affle (India) has a debt to equity ratio of 0.12, which is far from excessive. The combination of modest debt and a very impressive ROE does suggest that the business is high quality. Careful use of debt to boost returns is often very good for shareholders. However, it could reduce the company's ability to take advantage of future opportunities.

The Key Takeaway

Return on equity is one way we can compare the business quality of different companies. Companies that can achieve high returns on equity without too much debt are generally of good quality. All else being equal, a higher ROE is better.

But when a business is high quality, the market often bids it up to a price that reflects this. It is important to consider other factors, such as future profit growth -- and how much investment is required going forward. You can see how the company has grow in the past by looking at this FREE detailed graph of past earnings, revenue and cash flow.

But note: Affle (India) may not be the best stock to buy. So take a peek at this free list of interesting companies with high ROE and low debt.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.