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Many investors are still learning about the various metrics that can be useful when analysing a stock. This article is for those who would like to learn about Return On Equity (ROE). We'll use ROE to examine Astro Malaysia Holdings Berhad (KLSE:ASTRO), by way of a worked example.
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Put another way, it reveals the company's success at turning shareholder investments into profits.
Check out our latest analysis for Astro Malaysia Holdings Berhad
How To 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 Astro Malaysia Holdings Berhad is:
11% = RM128m ÷ RM1.1b (Based on the trailing twelve months to April 2023).
The 'return' is the profit over the last twelve months. That means that for every MYR1 worth of shareholders' equity, the company generated MYR0.11 in profit.
Does Astro Malaysia Holdings Berhad Have A Good Return On Equity?
By comparing a company's ROE with its industry average, we can get a quick measure of how good it is. However, this method is only useful as a rough check, because companies do differ quite a bit within the same industry classification. You can see in the graphic below that Astro Malaysia Holdings Berhad has an ROE that is fairly close to the average for the Media industry (9.7%).
So while the ROE is not exceptional, at least its acceptable. Even if the ROE is respectable when compared to the industry, its worth checking if the firm's ROE is being aided by high debt levels. If true, then it is more an indication of risk than the potential. Our risks dashboardshould have the 3 risks we have identified for Astro Malaysia Holdings Berhad.
Why You Should Consider Debt When Looking At ROE
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 case of the first and second options, the ROE will reflect this use of cash, for growth. 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.
Astro Malaysia Holdings Berhad's Debt And Its 11% ROE
Astro Malaysia Holdings Berhad clearly uses a high amount of debt to boost returns, as it has a debt to equity ratio of 1.47. The combination of a rather low ROE and significant use of debt is not particularly appealing. Debt increases risk and reduces options for the company in the future, so you generally want to see some good returns from using it.