While some investors are already well versed in financial metrics (hat tip), this article is for those who would like to learn about Return On Equity (ROE) and why it is important. By way of learning-by-doing, we’ll look at ROE to gain a better understanding AP Rentals Holdings Limited (HKG:1496).

Over the last twelve months AP Rentals Holdings has recorded a ROE of 8.6%. One way to conceptualize this, is that for each HK$1 of shareholders’ equity it has, the company made HK$0.086 in profit.

View our latest analysis for AP Rentals Holdings

How Do You Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit ÷ Shareholders’ Equity

Or for AP Rentals Holdings:

8.6% = 21.081 ÷ HK$246m (Based on the trailing twelve months to March 2018.)

Most readers would understand what net profit is, but it’s worth explaining the concept of shareholders’ equity. It is all the money paid into the company from shareholders, plus any earnings retained. You can calculate shareholders’ equity by subtracting the company’s total liabilities from its 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 yearly profit. That means that the higher the ROE, the more profitable the company is. So, all else being equal, a high ROE is better than a low one. Clearly, then, one can use ROE to compare different companies.

Does AP Rentals Holdings 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. You can see in the graphic below that AP Rentals Holdings has an ROE that is fairly close to the average for the trade distributors industry (9.2%).

That’s neither particularly good, nor bad. ROE can change from year to year, based on decisions that have been made in the past. So savvy investors often note how long the CEO has been in that position.

How Does Debt Impact ROE?

Most companies need money — from somewhere — to grow their profits. The cash for investment can come from prior year profits (retained earnings), issuing new shares, or borrowing. 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. That will make the ROE look better than if no debt was used.