In This Article:
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 DEFAMA Deutsche Fachmarkt AG (ETR:DEF).
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. Put another way, it reveals the company's success at turning shareholder investments into profits.
View our latest analysis for DEFAMA Deutsche Fachmarkt
How Is ROE Calculated?
The formula for return on equity is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for DEFAMA Deutsche Fachmarkt is:
9.5% = €4.2m ÷ €44m (Based on the trailing twelve months to March 2024).
The 'return' is the yearly profit. Another way to think of that is that for every €1 worth of equity, the company was able to earn €0.10 in profit.
Does DEFAMA Deutsche Fachmarkt Have A Good Return On Equity?
Arguably the easiest way to assess company's ROE is to compare it with the average in its industry. Importantly, this is far from a perfect measure, because companies differ significantly within the same industry classification. As is clear from the image below, DEFAMA Deutsche Fachmarkt has a better ROE than the average (6.9%) in the Real Estate industry.
That's clearly a positive. However, bear in mind that a high ROE doesn’t necessarily indicate efficient profit generation. Aside from changes in net income, a high ROE can also be the outcome of high debt relative to equity, which indicates risk. To know the 3 risks we have identified for DEFAMA Deutsche Fachmarkt visit our risks dashboard for free.
How Does Debt Impact ROE?
Most companies need money -- from somewhere -- to grow their profits. That cash can come from issuing shares, retained earnings, 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. That will make the ROE look better than if no debt was used.
Combining DEFAMA Deutsche Fachmarkt's Debt And Its 9.5% Return On Equity
It seems that DEFAMA Deutsche Fachmarkt uses a huge volume of debt to fund the business, since it has an extremely high debt to equity ratio of 3.76. Most investors would need a low share price to be interested in a company with low ROE and high debt to equity.