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. To keep the lesson grounded in practicality, we'll use ROE to better understand Jayant Agro-Organics Limited (NSE:JAYAGROGN).
Jayant Agro-Organics has a ROE of 13%, based on the last twelve months. Another way to think of that is that for every ₹1 worth of equity in the company, it was able to earn ₹0.13.
See our latest analysis for Jayant Agro-Organics
How Do You Calculate Return On Equity?
The formula for ROE is:
Return on Equity = Net Profit ÷ Shareholders' Equity
Or for Jayant Agro-Organics:
13% = ₹509m ÷ ₹4.0b (Based on the trailing twelve months to June 2019.)
Most readers would understand what net profit is, but it’s worth explaining the concept of shareholders’ equity. It is the capital paid in by shareholders, plus any retained earnings. You can calculate shareholders' equity by subtracting the company's total liabilities from its total assets.
What Does ROE 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 profit 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 ROE can be used to compare two businesses.
Does Jayant Agro-Organics Have A Good Return On Equity?
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. You can see in the graphic below that Jayant Agro-Organics has an ROE that is fairly close to the average for the Chemicals industry (13%).
That isn't amazing, but it is respectable. ROE can give us a view about company quality, but many investors also look to other factors, such as whether there are insiders buying shares. I will like Jayant Agro-Organics better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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. That will make the ROE look better than if no debt was used.