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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 Edel SE & Co. KGaA (ETR:EDL), by way of a worked example.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Put another way, it reveals the company's success at turning shareholder investments into profits.
View our latest analysis for Edel SE KGaA
How Do You Calculate Return On Equity?
ROE can be calculated by using the formula:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Edel SE KGaA is:
21% = €11m ÷ €50m (Based on the trailing twelve months to March 2023).
The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each €1 of shareholders' capital it has, the company made €0.21 in profit.
Does Edel SE KGaA 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. The image below shows that Edel SE KGaA has an ROE that is roughly in line with the Entertainment industry average (18%).
That isn't amazing, but it is respectable. Although the ROE is similar to the industry, we should still perform further checks to see if the company's ROE is being boosted by high debt levels. If so, this increases its exposure to financial risk. Our risks dashboardshould have the 3 risks we have identified for Edel SE KGaA.
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 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. Thus the use of debt can improve ROE, albeit along with extra risk in the case of stormy weather, metaphorically speaking.
Combining Edel SE KGaA's Debt And Its 21% Return On Equity
It's worth noting the high use of debt by Edel SE KGaA, leading to its debt to equity ratio of 1.11. Its ROE is pretty impressive but, it would have probably been lower without the use of debt. Debt increases risk and reduces options for the company in the future, so you generally want to see some good returns from using it.