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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). To keep the lesson grounded in practicality, we'll use ROE to better understand Energiekontor AG (ETR:EKT).
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. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
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How Is ROE Calculated?
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 Energiekontor is:
12% = €23m ÷ €188m (Based on the trailing twelve months to December 2024).
The 'return' is the income the business earned over the last year. So, this means that for every €1 of its shareholder's investments, the company generates a profit of €0.12.
See our latest analysis for Energiekontor
Does Energiekontor 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. 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 Energiekontor has an ROE that is fairly close to the average for the Electrical industry (13%).
That isn't amazing, but it is respectable. While at least the ROE is not lower than the industry, its still worth checking what role the company's debt plays as high debt levels relative to equity may also make the ROE appear high. If a company takes on too much debt, it is at higher risk of defaulting on interest payments. Our risks dashboardshould have the 3 risks we have identified for Energiekontor.
How Does Debt Impact Return On Equity?
Most companies need money -- from somewhere -- to grow their profits. That cash can come from issuing shares, retained earnings, or debt. In the case of the first and second options, the ROE will reflect this use of cash, for growth. In the latter case, the use of debt will improve the returns, but will not change the equity. That will make the ROE look better than if no debt was used.
Combining Energiekontor's Debt And Its 12% Return On Equity
Energiekontor clearly uses a high amount of debt to boost returns, as it has a debt to equity ratio of 1.92. While its ROE is pretty respectable, the amount of debt the company is carrying currently is not ideal. Debt does bring extra risk, so it's only really worthwhile when a company generates some decent returns from it.